Dividends - create passive income from the stock markets
A guide to dividend investing strategies
People usually turn to the stock markets to grow their money. It is mostly looked at as an area to build your wealth for the long term. It is not considered to be a stable source of consistent income by most.
The volatility of the capital markets is not a good source of passive income.
You must have heard this often.
But guess what? It is possible to create a pretty stable source of income from the markets. In fact, the process is quite straight forward.
Passive income investing
There are two ways to create a stream of income from the capital markets:
Trading - be it swing, intraday or scalping
Dividend investing essentially means following a strategy of investing in companies who issue regular dividends with the goal of creating a passive income source.
And we are about to tell you how to do just that!
But first, let’s confirm if it really is the best strategy for you.
Is dividend investing for you?
Typically, dividend investing is suitable for a person prioritizing passive income over capital growth. It would be most suitable for someone requiring regular income to cover her expenses. Such a person should possess good enough capital to invest as well, another requisite of a good dividend strategy.
The following graphic sums it up:
Stock Selection - what to look for in a stock
The dividend yield of a company is calculated as dividing their existing dividend by its current stock price. It simply measures the rate of return you get by buying a company's stock.
However, a company having a high dividend yield is not always a good sign. It can occur also when the company's stock price has declined considerably. It's better to revaluate your investment when a company's stock price declines by more than 20%.
Dividend payout ratio
The dividend payout ratio is the ratio of money a company uses to pay dividends from the net income attributable to its shareholders. You want a company that has a high ratio. Above 10% is considered good for this strategy, but some companies offer even more than 70%.
Many companies have a Dividend policy that you may find in their books. This means they are contractually obligated to pay dividends to their shareholders at regular intervals. Though your dividends are guaranteed, it comes at the risk of the company losing control over its money, especially during times of poor financial performance.
Some of our favorite dividend paying stocks are:
Hero Moto Corp
If you understand the concept, you would realize that regular dividends are given out by matured companies, having a stable market share and predictable revenue. You would most likely find such investments in the group of age old, blue chip stocks.
Short term strategies
A quick strategy adopted by many traders is the ‘dividend capture strategy’.
Just like it sounds, it is used by short term investors to scalp the dividend a company pays out. Buying the stock before its ex-dividend date or staying invested solely for a dividend capture are ways that one can adopt.
You might also see that the price of a stock appreciates just before the ex-dividend date in anticipation of a dividend payment and declines soon after.
Adopting a dividend strategy means letting go of a few important portfolio ingredients. Some of the risks are:
1) Good dividends, bad companies
Some companies strive to maintain their dividend policy even if they are loss making. They may do so because they have excess cash in reserves or simply because they want to maintain shareholders’ interest. Many of the times, they are public companies.
Taking Coal India as an example, see how it gave negative neturns over the past 5 years and yet maintained a dividend yield of 9.5%.
2) High capital requirements
If you plan to rely just on dividends for your income, you may require high capital. According to most financial planners, you can live off dividends if your annual expenses are within 4% of your total portfolio value.
3) Beware of tax
Remember that you are taxed as per your income tax slab for dividends. If the dividends exceed a certain amount, you may have to pay additional taxes.
To conclude, dividend investing is ideal if your focus is passive income over capital growth. Selecting stocks that have a balance of healthy growth and stable dividend yields would be an ideal strategy.