5 Risks Of Dividend Stocks To Be Aware Of

Having a company you are relying on for income cut its dividend is just one of the risks of dividend stocks.


Investing in a business simply based on its cash dividend record is a risky proposition.

Even if a firm has had a good history of payments and increased the total dividend return, it does not imply that it’s necessarily a safe and secure purchase, so investigate and do your own due diligence before investing.

By the end of this article, you will have a better understanding of:

  • What Is Dividend Stock?
  • What are The Risks of Dividend Stocks?
  • Pros And Cons Of Dividend Stocks
  • Dividend Stocks: How To Make A Loss.
  • The Risks Of Pursuing High Dividend Stocks

 

What Is A Dividend Stock?

A dividend stock is a publicly-traded firm that pays dividends to its stockholders on a consistent schedule. These businesses have usually been successful for a while and are committed to paying out dividends for the foreseeable future.

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Dividend payments can account for a considerable amount of an investor’s average return over time. Although this style of investing is less thrilling than pursuing the newest high-flyer or “to the moon” type stock in the market.

Woman tightrope walking to represent the risks of dividend stocks

Pros and Cons of Dividend Stocks

 

Pros

  • Dividends can be a reliable source of financial earnings.
  • If the price of the investment rises over a period, an investor can sell it for a return. This is on top of what they were receiving from the dividends. You can think of it as another way to benefit from this investing style

Cons

  • If the corporation in which investors own stock experiences financial difficulties, the dividend payout to shareholders may be reduced or even cut completely
  • Stocks can both gain and drop in value. Sometimes this drop can be higher than you have received from the dividends. This is one of the biggest risks of dividend stocks.
  • Dividend payouts may be subject to taxation because they are considered part of the investor’s income. This really depends on where you live and your current financial and tax status but in most cases, some taxes will have to be paid on the income you receive from dividends.
  • There is no assurance. You can’t ever truly rely only on dividends coming in because firms don’t always pay them and they are not guaranteed. Some companies are more likely to pay than others but there is always a risk.

 

What Are The Risks Of Dividend Stocks?

 

Any one of the following scenarios can cause shareholders to lose revenue while trading in dividend-paying stocks:

1. Broad-based stock prices experienced a downturn

If an investor holds dividend-paying equities for the long term, they are likely to see one or even more big stock market drops.

As a consequence, their dividend-paying stocks decrease in share price.

E.g.

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  • 2001 – The stock market bubble in technology popped.
  • 2008 -The housing market collapsed leading to the great financial crisis and credit crunch.
  • 2020 – A pandemic outbreak and a worldwide health emergency

 

2. Some dividend stocks that consumers own might underperform over long periods

 

When picking individual stocks, investors may select dividend stocks that will underperform the market return over the holding period.

This underperformance is most likely a consequence of the corporation’s economic and business performance concerns.

As a result, the stock drops or may only rise at a lackluster rate and underperforms the general market.

This stock price underperformance could be due to internal troubles at the company or could be due to external factors.

 

Internal factors

  • Poor decision-making abilities
  • Poor execution
  • Poor business decisions
  • Inability to recruit and maintain top talent
  • Poor quality control

 

External factors

  • Lawsuits
  • Government rules and restrictions
  • Aggressive competitiveness
  • Shifting consumption patterns
  • Obsolescence due to technological advancements

 

risk meter showing medium risk

 

 

3. Buying high-yielding but high-risk dividend companies

It’s hard not to be tempted by high dividend-yielding stocks as a dividend trader. Those 5.5%, 6.5%, 7.5%, (and sometimes even higher!) dividend rates appear to be so appealing.

A stock with a larger dividend yield may well be dealing with additional investing risks, which is an issue.

  • Revenue growth is slow or non-existent.
  • Slowed dividend growth
  • Unrealistic dividend payout ratio
  • The chance that dividends will be eliminated, reduce, or suspend

4. Inflation erodes dividends.

In most countries around the world, and the UK is certainly no exception, inflation has begun to accelerate sharply. Inflation, on the other hand, causes a lot of problems for dividend stocks.

First, inflation somewhat reduces the purchasing power of dividend payments received by investors. The impact of this is usually overstated by new investors but there is still some effect that inflation has on your returns

Second, higher interest rates are usually associated with inflation. And increasing interest rates normally harm dividend equities’ valuation.

5. Switching strategy too often

Keep in mind that dividend investing necessitates patience.

It isn’t a get-rich-quick program by any means.

It requires time and effort. To choose the proper dividend stocks to invest in you should purchase them at the appropriate time and then ideally keep holding onto them for the long term.

As the investor moves ahead, he or she should make judicious acquisitions and modifications to the dividend investment portfolio.

For those considering dividend-investing strategies, there are usually two basic approaches to examine:

  • Dividend yield

The first strategy is to buy stocks or mutual funds with high current dividend rates. These businesses may be cheap or have a business problem, resulting in a drop in stock costs and an increase in dividend yield. To solve financial troubles, the payout may be reduced or even canceled in rare situations.

  • Dividend growth

Another alternative is to invest in businesses or collective investment schemes that have raised their dividend steadily over time. These stocks have lower returns than elevated stocks, but they are typically robust fundamental companies with a track record of increasing earnings.

 

The Risks of Pursuing High Dividend Stocks

A high dividend return could suggest that a company is in trouble. Since the company’s shares have plummeted in reaction to financial hardship, the return may be high, and the suffering business hasn’t decreased its dividend already.

Investors should look at the financial position of a company that pays continuous dividends, which requires looking at net income, previous dividend payment ratios, and other cash-flow indicators.

Higher interest rates put dividend stocks at risk. Dividends are becoming less appealing as interest rates go up, relative to the risk-free return rate provided by public assets.

 

Bottom Line

So to summarise and answer the question – What are the risks of dividend stocks?

The following are the main risks:

  •         General stock market crashes
  •         Dividend stocks that consumers own are at risk of underperforming
  •         Trading in high-yielding, high-risk dividend companies
  •         Inflation eroding low growth dividends.
  •         Denying an investor’s dividend investment strategy

 

 

 

 

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