Hi, I am new to stock investing. Should I invest for capital gains or dividend yields?
There is no right or wrong answer to this question. It is possible to build yourself a sizable portfolio regardless of your own preference between the two. With that said, however, after communicating with our pool of readers at Bursaking.com.my and KCLau.com, I think, it is better for you to focus on investing for dividend yields if you are a complete beginner.
1. Dividends are More Predictable
Dividend income is more predictable than estimating capital gains. After all, dividends are cash whereas capital gains are merely paper gains and are subject to changes on a daily basis. Your investment returns would not be “yo-yoed” based on the ups and downs of the stock market.
Instead, you’ll enjoy the certainty of income flowing into your bank account on a periodic basis if you choose to invest for dividends.
2. Dividends Pay Your Fixed Bills
This leads to Reason #2. Regular dividends pay your fixed bills which include your rent, mortgage, car loan, utility bills, Astro, insurance and grocery. Even if you had the above covered, it is nice to have a nice “makan” out, movies, dating, wall climbing, or a ‘Cuti-Cuti Malaysia’ trip paid for with dividends.
3. Dividends Build Your Confidence
Often, investors see their first dividend income flowing into their bank accounts within three to six months after making their stock purchases. Subsequently, based on the stock purchased, they would receive dividends either on a quarterly, semi-annually or annual basis.
Imagine, being a new investor and starting to earn cash returns every three months from your portfolio, you would probably feel good regardless how the price of your stock is moving. Even if the stock falls in price, you would continue to receive cash returns from it. At least, the stock will be “good for something”, and it will incentivise you to keep it over the long-run.
4. Dividend Investing is Less Risky
Here is a definition of a good stock investment. It is one where the stock has excellent fundamental qualities, and its price is attractively undervalued. In other words, the stock must be good and cheap. Often, stocks which are consistent in their dividend payouts possess great fundamental qualities.
These include having a resilient business model, excellent management team, a healthy balance sheet and a proven track record of growing profits consistently. As such, you would minimise your risk or chances of making poor investment decisions if you just stick to stocks that have the qualities above.
5. Dividends Build Your Portfolio
Earlier, we had mentioned that you could use dividends to pay for your expenses. But, what if you are currently making tons of money and do not need to rely on dividends to fund your current lifestyle? Is dividend investing still suitable for you?
The answer is Yes. This is because you could reinvest your dividend income into another dividend stock or stocks that you prefer, thus, allowing you to further expand your portfolio in the future.
Over time, you may not need to save money to invest, but use your dividends to fund your future investment. It works like a cycle where you use profits to generate more profits.
6. Why Not Capital Gains?
Does it mean that investing for capital gains is not good? Nope. Investing for capital gains is good if you are a more sophisticated investor. Being a skilled investor, your chances of achieving capital gains will be higher than one who is unskilled.
In most cases, people who are into capital gains without any sort of skills are often gamblers and speculators in the stock market. They are often thrill-seekers who see the stock market as a legalised casino.
They are not necessarily profit-driven, and this differs from the mindset of stock investors who are very profit-driven.
7. Dividend Investing is Investing with Clarity
How do you tell the difference between an investor and a speculator? It is quite easy. First, if a person tells us that he is investing for capital gains, we ask him: “How much capital gains are you expecting?” If his reply is: “I don’t know” and often, that is quite a standard reply, I would classify him as a speculator.
This is because true investors have already calculated their expected returns before buying into a stock or any investment. For example, if you ask a dividend guy what he is investing for, his reply would usually be: “I’m expecting to make at least 5% ─ 6% from this stock investment.”
Definitely, he is investing with clarity and with purpose, and not so much into luck, rumours, tips, or comments.
8. Dividend Investing is Simple
Dividend investing helps new investors to make stock investment decisions easier, faster and better. These decisions are mostly based on facts and figures, logic, and common sense. Thus, if you know how to do some simple maths, you can become successful in dividend investing.
Here’s a quick way to determine whether a stock is undervalued or overpriced. First, the reason why people invest in stocks is to earn more than banks’ Fixed Deposits of around 3%. Hence, any stock with dividend yields below 3% is overpriced.
However, if the dividend yield of a stock is 5% and above, investors may look into it as it is considered to be undervalued at its current price. Thus, dividend investing is a simple system which promotes one to “Buy Low, Hold for Dividends, and Sell High”.
Dividend Yield = (Dividends per Share / Current Stock Price) x 100%
9. Dividend Investing is Investing for Capital Gains
What? Am I serious? Yes. Investing for dividends is investing for capital gains. Why? Because stocks with consistent dividend payouts are in demand by a larger pool of investors. They include EPF, KWSP, Tabung Haji, insurers and mutual funds, particularly income funds.
These institutions have billions and are still receiving billions for investment purposes. In this time when the markets are uncertain and volatile, these large institutional investors may be adopting a defensive stance to their portfolio as they are expected to perform and deliver returns to their stakeholders.
It may explain why dividend stocks tend to achieve sustainable capital appreciation over the long-term.
About the author
This article is co-written by KCLau and Ian Tai.
KCLau is a financial educator. He had published 6 books and co-created a dozen online financial courses. You can download his popular Money Tips e-book packed with 44 money hacks absolutely free, here: http://kclau.com/lp
Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.