Why Dividend Stocks Are Such A Safe Investment By Guest Blogger Imogen Reed. All investors want just two things for their money: a high a yield as possible, and a safe an investment as possible. An investment that is both safe and pays out a high yield is the Holy Grail, but is not easy to find. Investments usually vary from high risk and high payout, to relatively safe but low yield. Finding a good compromise between high yield and low risk is the secret to successful investing, which is why so many people choose dividend stocks.
Just as paying by plastic is often the safest way to shop, dividend stocks are perhaps the safest option for building up an investment portfolio. Unlike bonds, which are relatively low yield, and real estate, which offers better rewards but far greater risk, dividend stocks, not only offer attractive yields, but also are one of the safest places to invest your money.
What Defines a Safe Investment?
What determines a safe investment is fairly subjective. For some, a safe investment is one where you are not going to lose your capital. In this definition, simply keeping your money in the bank will be the safest option, although you won’t make much money that way. For others, a safe investment is one that always has a positive yield. However, many investments that people often consider safe, offer investment yields that can fall under the average rate of inflation, which means that while the figures go up on paper, in real terms, the investment is losing money during periods of high inflation.
A better way of defining a safe investment is one that not only keeps any capital safe, but also over time, protects money against fluctuating inflation, something that dividend stocks do better than nearly any other investment opportunity. Of course, there may be periods when inflation temporarily shoots up to excessive levels, but these periods are exceptionally rare. A mistake many dividend holders make is to panic and sell off dividend stocks if the economy hits a trough and inflation happens to shoot up. Over the last century, the historical average rate of inflation in the United States is just over 3%, and this includes massive spikes during two world wars. As most leading dividend stocks payout rates in excess of 5%, in the long term, this makes these stocks safe investments. Because many people invest to build up a retirement nest egg, dividend stocks paying yields over the historical average are perhaps the safest place to invest in your future.
Dividends are a Sign of company Health
Companies can only justify paying dividends if they have paid all their other bills. While it’s not unheard of for companies to offer dividends that they can’t afford, a would-be investor can easily check a company’s financial health to see if they are acting irresponsibly. Looking at the cash flow statement in an annual report will give a clear indication as to whether a company has paid their tax, debt and capital payments.
High growth companies often don’t pay dividends at all, especially new businesses as they choose to plow the money back into the company to maintain growth. However, as companies become better established, dividends become an attractive means of interesting and sustaining investors. Because of this, dividends become a good indicator as to the financial stability of a company. In fact, stockbrokers often use this indicator to establish the general health of investment opportunities.
Easy to Spot Warning Signs
The best dividends are those that are backed by established and solid companies, which have a good track record of strong cash flow and predictable profits. While these companies may not offer the highest payouts on the market, many still provide yields well above the historical average rate of inflation, making them an incredibly safe long-term investment. Investing in these companies also means your capital is going to be well looked after.
There have been, however, incidents of irresponsible dividend payments in the past, but these can easily be spotted. The most obvious warning sign is overly excessive dividend yields. This may be a sign the company might not be able to maintain payments, is about to be sold, or is dire need of quick cash. An investor should be wary of dividend stocks offering yields over 10%, unless the company has a really well established reputation and solid financial background.