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Investing in dividend stocks is one of the most popular strategies used by investors to save for retirement. Dividend stocks provide investors with a continuous stream of income while at the same time retain the potential for capital gains on the amount invested.
This is pretty similar to bonds, although with bonds you are guaranteed to receive your principal at the end of the period, barring instances of default risk.
Even though government bonds were in the past considered safer, the picture appears to be changing, especially given the current low return levels. As a result, investors continue to pursue alternative investment vehicles such as dividend stocks.
Dividend paying stocks are constantly sought due to their ability to offer a higher yield capacity. But whether you are investing in bonds or dividend stocks, the risk factors are pretty similar and each option presents its own pros and cons.
Benefits of bonds investing
How do bonds work to your best interest as an investor? Experts have simplified the procedure by alienating bonds from regular stock investments as a mere debt to equity comparison, profitability and interest rates.
Debts are sort before equities
What are bonds? Bonds are described as debts while stocks can be referred to as equities. Generally, investing in debts is considered safer than investing in equities. When an organization is declared bankrupt, a debt holder will be compensated before a shareholder enters the line.
In fact, in a situation where the organization has been hit badly by a crisis, the creditor (debt holder) may get some of his or her money back while the shareholder may end up losing the entire sum.
Predictable profits
Although major statistics showcase that stocks will rally against bonds in the near future, in the economic cycle, bonds have also shown that they can do better than stocks.
During economic hardships such as an unforeseen recession, stocks may lose close to 10%, but if you had added bonds to your portfolio, they could assist in maintaining a smooth balance before the market picks up.
Better interest rates
Bonds provide a better way of growing an investment by taking low-to-zero risk, depending on the type of bond you invest in. Some government bonds and bills provide attractive risk-free return rates compared to putting your money in an interest bearing account at a bank.
This method of investing is particularly sought by young investors who want to save towards their education or people with money that they may not need to use in the short term.
Benefits of dividend stock investments
Dividend stocks provide investors with periodic payments and potential gains on money invested when they decide to sell the stock at a profit in the future. However, not all stocks provide good opportunities for dividend investors. Therefore, while there are several benefits associated with dividend stocks, it is important to choose your stocks wisely.
Pivotal role on total market returns
Since 1956, S&P ratings have showcased that dividends have held ground and made up to 40% returns on investments. When you add this to the potential capital gains, dividend stock investing appears to offer better returns than investing in bonds.
Investment risk safe haven
Established organizations usually pay dividends because they have already created workarounds to safeguard against unpredictable market trends, among other economic shakeups.
For example, over the last 42 years, Fortis Inc. (FTS, Financial), an electric utility company, has rewarded its investors remarkably by paying dividends year after year. The latest reports have indicated the company now yields 3.6% and a payout ratio of 60%. This shows that it still has room for improvement.
Income tax-free favorites
Dividend payouts draw minimal tax rates and thus have been considered tax havens for stock market investing.
Which is better for you?
Some investors would certainly choose dividend stocks while others may decide to choose bonds.
There are a few reasons why an investor could prefer one over the other.
Age: Elderly investors may choose dividend stocks over bonds if they believe that by the time the bond matures, they may not be around to receive the principal.
Risk: Although good dividend stocks are believed to be low-risk investments, they still cannot compare with bonds.
Tolerance: Bonds tend to be less volatile than stocks, even for the most stable companies. Some investors cannot tolerate the volatility of the stocks, which presents the potential to receive less than what they invested once they decide to sell the stock.
Stage of life: Young people are risk-takers since they have all the time in the world ahead of them. They are often suited for high risk investing. In addition, they also have the time to invest in bonds that expire several years down the line. As such, they can always mix and match their assets to come up with a balanced portfolio.
Conclusion
Dividend paying stocks are still vulnerable like all other stocks, but the fact investors can receive some sort of compensation before selling their stakes comes as a welcome bonus, especially during bear markets.
On the other hand, investing in bonds is seen as the prudent route to take when markets are highly volatile or during economic meltdowns.
Disclosure: I am not long any of the stocks mentioned in this article.
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