CREATING A DIVIDEND
INVESTING STRATEGY

This article will explore various dividend investing strategies, and guide investors on how to create one that suits their goals, and is in line with their own appetite to risk.

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Once you start building a dividend investment strategy, you will soon realize how the regular drip feed of dividend payments has the potential to support your overall returns through passive contributions and compounding. 

To some extent, dividend stocks will take care of themselves, but that doesn’t mean that there aren’t approaches you can take to optimize your returns and better align your dividend strategy with your overall investment goals. For instance, choosing particular portfolio management techniques can keep your investments on the right track toward helping you achieve your financial goals. 

Types of dividend investing strategy

Dividend strategies are available for all types of investors. Some are more labor-intensive than others, and they can also be set up to prioritize short-term or long-term aims.

Dividend capture strategy

Adopting a dividend capture strategy can take your dividend payouts to an extreme level. This rather specialist strategy focuses on generating dividend income by buying stocks just before their ex-dividend date (or “ex-date”).

Investors who are holding stock on ex-date will be eligible to receive a dividend, regardless of when they purchased the stock and whether they then sell the position straight away.

Some investors who use this strategy will hold positions for only a few days before moving their capital into another stock.

A dividend capture strategy certainly has the potential to boost the percentage of your returns received in the form of dividend income, but it is important to be aware that there are reasons it might not actually improve your overall returns. 

For example, rotating in and out of positions will incur trading costs which can impact performance. The time taken to research and monitor different positions also needs to be factored in as a “cost” of some sort. What’s more, if you hold positions for a short period of time, you may not receive any of the beneficial tax treatment which is reserved for longer-term investments. 

The main factor working against the dividend capture strategy, however, is that dividends are factored into stock valuations in the run-up to ex-date. After the dividend ex-date comes around, the stock can be expected to fall in price, as buying the stock no longer includes an element of dividend income. It is possible that the price reduction will be less than the size of the dividend payment, but it could also be greater and, thus, result in a capital loss.

Diversification

Diversification is another crucial component of a dividend investing strategy. There are many reasons why spreading capital across different types of assets is a good idea. A diversified portfolio has less exposure to single-stock risk, reducing the chance that one position will drag down your overall performance.

Macroeconomic cycles which cause the financial markets to rise and fall in value are unavoidable, and portfolio diversification will make it easier to navigate the natural ups and downs of the economy. Moreover, diversification can help you to mitigate losses in the case of an individual company missing targets, having a poor earnings season, depreciating in stock value or experiencing situations such as bankruptcy.

Your portfolio being overexposed in any one position will not only impact your bottom line, but could result in panic-inspired decision-making. Constructing and implementing diversification strategies to avoid overexposure will help you to stick with a carefully thought-out investment strategy. 

Dividend investing is about taking the long-term view and aiming to track (rather than beat) the market while receiving a passive income along the way.

Holding a large number of individual stocks (both dividend-paying and not) is the first part of the diversification process, but diversification requires more than just holding a large number of positions. A well-diversified portfolio avoids being concentrated in any particular sector, industry, or region and will also spread exposure across a mix of small-, medium—and large-cap stocks. 

Which dividend strategy is right for me? 

Your personal investment aims should always determine which dividend strategy you adopt. Younger investors with a longer investment time horizon may opt for a strategy that focuses on the benefits of compounding and long-term returns.   Alternatively, retirees with more free time to manage their portfolios and a desire to maximize short-term cash flow may opt to pursue a dividend capture strategy. 

There is also a need to establish to what extent you want to prioritize allocating capital to capture dividend income and forego potential capital gains associated with asset groups such as growth stocks.

Final thoughts

The good news is that there is a dividend strategy that exists to suit most objectives. Establishing your investment aims is one element of investing which is within your own control, as is factoring in rebalancing opportunities and ensuring to monitor your portfolio. Designing a plan that you can stick to, but that is flexible enough to accommodate changes relating to your personal circumstances or market conditions, is also key. 

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FAQs

What is a value trap stock?

A value trap stock is one which appears cheap according to standard valuation metrics but is not a good buy because of some other factors. In the case of dividend stocks, a high dividend yield might make a stock look attractive, but it could be that the stock price has fallen because the firm’s management has signalled that future dividends are going to be lower than expected. 

Should I look for high dividends or growing dividends?

This will depend on your investment aims. If receiving short-term income is your priority, then high-dividend stocks or the iShares Core High Dividend ETF would generate a more immediate cash flow. A stock with smaller but growing dividends signals that a company’s underlying business is improving and that it could be a better long-term bet.

Do unrealistically high dividend payouts threaten the future of dividend investing?

Yes. Some firms pay dividends partly because their shareholders expect them to. Not doing so could cause the stock price to crash as dividend investors exit positions. If your research identifies that a dividend is being paid despite that not being supported by the business fundamentals, then the stock price and dividend payouts could both fall as more investors draw the same conclusion.