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3 Myths About Dividend Stocks (1)

3 Myths About Dividend Stocks That Can Be Dangerous

People love passive income.

Nothing feels better than having cash money deposited into your bank account. For doing absolutely nothing.

That's the beauty of stock dividends.​ Buy a dividend paying stock, hold onto it for years, and every quarter get a little "paycheck". A dividend is the cash that a company returns to the stock owner, usually once a quarter.

But some investors don't completely understand dividend stocks. Or they believe in things that just aren't true.

Here are 3 myths about dividend stocks that can be dangerous.​

Myth #1: Higher Yield = Good

People get excited about super high dividends. I understand it.

When you see a stock paying 8%, 10% or 14% it seems like an incredible income.

But remember this: Every time that dividend is paid, the stock price is lowered by the same amount.

What? No way! Yes way.

When a company pays a cash dividend, it's no longer in the company's bank account. So it can no longer be counted as an asset of the business. 

So the value of the business goes down by that amount. It's done every time. Automatically.

Now, that's not to say the stock price doesn't recover. It can. Especially over a longer time. But maybe not in the short term.

If you invest $100 in a 14% dividend yielding stock, don't think you're going to get $114 at the end of the first year.

I like dividend stocks that pay a decent rate (3-5%), but that reinvest in their business growth. That can mean raising he dividend in the future AND the stock price going higher.

That's a win-win.​

Myth #2: Dividends are fixed and don't change

I once had a client say of a 6% dividend stock: "Well, at least I know I'm going to get a minimum of 6% return!"

Nope.

While there are lots of companies who pay a consistent dividend (and some raise it over time), there's no guarantee.

The crisis of 2008 proved this. Tons of "safe" dividend stocks not only dropped in stock price, they also cut their dividends or eliminated them altogether. 

Talk about a double whammy!

Remember that dividends can be changed (up or down) or stopped.

Myth #3: Dividend stocks are safer than non-dividend stocks

While this can be true, it's not an absolute.

One risk that dividend stocks have that non-dividend stocks don't has to do with interest rates.

Many investors have bought dividend stocks as substitutes for interest paying investments, like CDs and bonds.

But when interest rates rise, this can hurt dividend stocks.

Why? Because the relative income versus the risk of owning a stock changes. 

Given a certain income/dividend rate, investors will choose the safest option. If that's bonds, then investors who own dividend stocks may sell them and move into the safer bonds.

That selling would be negative for dividend stocks.

Summary

Dividend stocks can be a great way to generate passive income.

Just remember these 3 myths about dividends:

  1. Higher dividend = good - There's no free lunch. When that dividend is paid, the stock price goes down.​
  2. Dividends are fixed and don't change - Wrong! Dividends can go up or down or be eliminated altogether.
  3. Dividend stocks are safer - Nope. Just different kinds of risks with different investments.

Make sure you know what's going on before you invest.

Lesson: Make it part, just not all of your portfolio

Dividend investing should be part of an overall investing portfolio. Just not all.

The bottom line is that all investing has risks. They just may be different types of risks.

Knowing what they are will make you a better investor.​

And now you know more about dividend investing!

Let me know your thoughts in the comments below.

Thanks!

Tommy Sikes​