Believe it or not, these stocks pay you to own them
VSChoosing the right investments is key to building a healthy portfolio, but it can sometimes be difficult when there are seemingly endless stocks and funds to choose from.
The types of investments you choose will largely depend on your investment style and risk tolerance. Some people may prefer buying individual stocks, for example, while others prefer mutual funds or exchange-traded funds (ETFs).
Whatever your preferences, however, there is one type of investment that actually pays you to own it: dividend-paying stocks.
What are dividend stocks?
When a company starts making a profit, it has several options for allocating that money. Some companies choose to return a portion of their profits to shareholders, and this payment is called a dividend.
To earn dividends, all you have to do is invest in a stock that pays them. Most dividend stocks pay out quarterly or annually, and you’ll earn a small amount for each stock you own.
By investing regularly, you could potentially generate a source of passive income with dividend-paying stocks. While each individual payout can be small (usually just a few dollars per share), when you own hundreds of shares after a few decades of steady investing, those payouts add up quickly.
One of the best benefits of investing in these stocks is the ability to reinvest your dividends. With this strategy, rather than cashing in your payouts, you can reinvest that money in more shares of that particular stock. This can help grow your portfolio exponentially. The more shares you own, the more dividends you will reap. And the more dividends you receive, the more stocks you own, and the cycle continues.
Choose the right actions
There are countless dividend stocks to choose from, but it’s important to do your research before buying.
One factor to consider is the dividend yield, which is the ratio of a company’s dividend payment to its stock price. In general, a higher dividend yield is better because it means the dividend is larger relative to the stock price.
However, if a company’s dividend yield is too high, it could be a red flag. Sometimes an above-average return indicates a decline in the stock price, for example, or that the dividend payment is not sustainable.
When investing in dividend-paying stocks, your best bet is to simply focus on buying strong companies with long-term growth potential. If those stocks also pay a dividend, that’s a bonus.
How to start
Dividend Aristocrats, a group of companies that have increased their dividend payouts every year for at least 25 consecutive years, are a great place to get into dividend stocks. Not only are these stocks with strong dividends, but they are also overall sound companies and solid investments.
You can also invest in multiple dividend-paying stocks at once through a dividend ETF. Funds like Vanguard High Dividend Yield ETF (NYSEMKT: VYM) or the ProShares S&P 500 Aristocrats ETF (NYSEMKT:NOBL), for example, include dozens or hundreds of stocks that have always paid dividends. By investing in an ETF, you can easily diversify your portfolio with just one investment.
Dividend stocks can be a smart option for creating a source of passive income, but choosing the right investments is key. By doing your research and buying high-quality stocks, you can build a solid portfolio that will pay off more than you think in the long run.
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Katie Brockman has no position in the stocks mentioned. The Motley Fool owns and recommends ProShares S&P 500 Aristocrats ETF and Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.