Investing In Dividends For Dummies. Carrel Lawrence
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buy shares to assemble a portfolio, you shift to a more “big picture” perspective. Although you must micromanage the portfolio by keeping an eye on each investment, you also need to evaluate how each investment fits into your master plan and ultimate investment goals.
Settling on a stock-picking strategy
Every investor has a unique investment strategy for spinning straw into gold. Usually the best approach is a combination of several strategies to achieve the right balance of risk and return while efficiently reaching the investor’s goal.
The following are some semi-famous strategies that investors have developed for picking dividend stocks:
✓ The Dogs of the Dow: In 1991, Michael O’Higgins proposed an investment strategy called The Dogs of the Dow based on the fact that a dividend stock’s yield rises whenever its share price drops. Proponents of this theory believe that the components of the Dow Jones Industrial Average with the highest dividend yields have the greatest potential for capital appreciation in the coming year.
✓ The Geraldine Weiss Approach: Geraldine Weiss, editor of Investment Quality Trends (www.iqtrends.com), is a leading expert on dividend investing who promotes buying high-yield blue-chip stocks. The overall strategy is to buy high and sell low – that is, buy when dividend yields are at the historic highs and sell when the dividend yields hit historic lows. Sticking with blue-chips helps avoid financially troubled companies.
✓ Relative Dividend Yield: Developed by money manager Anthony Spare, this approach rates stocks by comparing a company’s dividend yield to that of the average yield of the S&P 500. In his book Relative Dividend Yield: Common Stock Investing for Income and Appreciation, 2nd Edition (Wiley), Spare recommends giving careful consideration to stocks with a dividend yield that’s more than double the average on the S&P 500.
✓ Dividend Achievers: Dividend Achievers identifies companies that have an outstanding track record for increasing dividend payments every year. To make it on the U.S. Broad Dividend Achievers Index, U.S. companies must have at least ten consecutive years of increasing regular dividends, be listed on the NYSE or NASDAQ, and have a minimum average daily cash volume of $500,000.
Limiting your exposure to risk
In the world of investing, risk is an ever-present reality, but you can implement several strategies to limit your exposure:
✓ Education and research: Knowledge is power, and by reading this book, you’re already engaged in the pursuit of the requisite insight and know-how.
✓ Dollar cost averaging: Dollar cost averaging is investing a fixed amount of money at regular intervals (such as monthly) toward the purchase of a particular investment. With dollar cost averaging, sometimes you pay more for the investment and sometimes less. This strategy reduces your chance of paying a premium for a large number of shares and then losing a huge amount of money when the price drops.
✓ Diversification: Don’t put all of your golden goose eggs in one basket by investing heavily in any one company, sector, or type of investment. By diversifying your portfolio with stocks, bonds, and cash, you not only spread the wealth but also lower your risk profile.
✓ Strategic timing: No, I’m not recommending that you try to time the market. What I do recommend is that you match your investment strategy to your time frame. Be aware of how many years you have before you need this money. The less time you have, the more conservative your investments should be. As you get older, consider allocating a higher percentage of your portfolio to safer investments, such as bonds, to protect your capital.
Buying and selling shares
After dealing with all the preliminaries, including settling on an investment strategy and carefully researching individual stocks, you’re almost ready to start trading. Almost, because you need to address one more preliminary – how you’re going to go about buying and selling shares. You basically have three options:
✓ Direct: You may be able to purchase shares directly from the company. For more about direct purchase programs, see Chapter 6.
✓ Broker: Brokers buy and sell shares on commission. In other words, they execute trades on your behalf. A full-service broker charges more but may offer some valuable insight and advice. A discount broker merely processes your order. If you’re a do-it-yourselfer, this route is the way to go.
✓ Investment advisor: A registered investment advisor is a step above a broker. An advisor can help you build and manage a portfolio to meet your financial goals, recommend stocks and other investments to consider, and meet with you regularly to make adjustments.
Reviewing your portfolio regularly
In the best of all possible worlds, you can build your portfolio and let it set sail without a care in the world. In the real world, you must continue to invest at least some time and effort reviewing your portfolio and making adjustments. Monitoring dividend stocks consists of reevaluating them regularly, using the same criteria you used to select them in the first place: dividend, yield, price-to-earnings ratio, payout ratio, and so on. When you notice the performance of one of the stocks in your portfolio slipping or have reason to believe it will start slipping, you may need to replace it with a better prospect. In addition, you probably want to make adjustments to your portfolio as your goals change. At the very least, you should check your portfolio twice a year to make sure your asset allocations match your strategy.
Staying on top of possible tax code changes
Tax legislation can make investing in dividend stocks more or less attractive. For many years, dividends were taxed as ordinary income – at a rate as high as 39.6 percent. In other words, for every dollar in dividends, investors had to fork over about 40 cents to Uncle Sam. In 1981, when the rate on long-term capital gains was reduced to a maximum of 20 percent, many investors shifted from dividend to growth stocks to give themselves a tax cut.
The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) changed all that. It dropped the tax rate on long-term capital gains and dividends to a maximum of 15 percent, leveling the playing field.
Investment vehicle is a fancy term used to describe an investment product other than basic stocks or bonds. Sometimes it refers to a product, such as a fund, which holds many different stocks or bonds. Other times, it refers to a way to purchase stocks or bonds other than a straightforward purchase. Some examples are
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