Dividend Investing Mistakes
Everyone is going to make mistakes when it comes to investing, be they beginners or those with years of experience. The most important thing about dividend investing mistakes is to minimize them and learn from them.
Below is a list of 10 dividend investing mistakes to avoid if you want to make better investment decisions. This list comes from personal experience, having worked for a few large investment firms in the past. The client base that I worked with were notable for their high net worth, and I had the privilege of monitoring and placing trading on their accounts.
I have learned a lot from my mistakes, and you and your portfolio can benefit from that experience. I hope to help you reduce your overall risk in your portfolio, by avoiding the biggest investment mistakes.
10 Mistakes Dividend Investors Make
Mistake #1: Buying a Stock Only on a Tip
The first of the beginner dividend mistakes does not refer to getting information from a top senior manager of a company. That’s what is known as insider information (and is illegal). I am referring to getting stock advice from a family member or someone in the media who follows the stock market.
It is okay to think about a potential investment based on what others say, but you still need to do your own homework. Besides needing to be certain that the capital in the investment will be preserved and generate an income, research will show if the investment is best suited to you.
Things to factor in would be the risk tolerance of the investment, its suitability within your portfolio, and whether you understand the company’s business model. If you can answer yes to all of these questions, then consider an investment in the company.
The worst investment decision you can make is to purchase shares in a company blindly. Simple research will avoid the risk and regret from an investment not working out as planned.
Mistake #2: Buy Shares Only for the Dividend
While working in the investment management industry in the past, I would see this quite often: long-term investors turning into short-term dividend traders.
You see, in order to receive a dividend, a stock would only need to be held for one day and could be sold the next. Before going into more detail, let me explain how this works, and the important dates.
Declaration Date: This is when the dividend is made public to the markets. How much the dividend payment will be is also made available this day.
Ex-Dividend: I would say this is the most important date, since receiving the dividend payment is based on it. This is the date that is associated with owning the shares for one day. The shares would have to be owned the day before the ex-dividend date at the latest (May 10 in this example). Then, were the shares to be sold on May 10, the dividend would still be received. If the shares were purchased on this date, whoever, the buyer would receive nothing.
Record Date: This is the date that the company records as when all eligible shareholders will receive the dividend.
Payment Date: This is the date that the payment will be received.
This might sound like a great strategy at first, and it may work out once or twice, but the one time it doesn’t work could result in you losing more than all your gains combined. Also, this strategy means that the company’s fundamentals, business model, and management team go completely ignored, with the focus is solely on the dividend. In other words, this is not a great long-term strategy.
To add, let’s say you purchase the stock and it starts to slide before you receive the dividend; you then wait until the share price is exactly the price you purchased it at. This may not occur anytime soon, and you could have purchased the shares at a peak, since the future is unknown.
Mistake #3: Focusing on the Current Dividend Yield
What sounds more appealing, a dividend yield of 5.88% or 12.11%? The obvious answer is 12.11%.
However, a higher yield does not mean it is a better investment; it could actually mean it has more risk. After all, a company with a dividend in place always has the choice of cutting or eliminating the dividend if it is unable to afford the payment.
A dividend yield is calculated by taking the annual dividend payment and dividing it by the current share price. For instance, if the current annual dividend payment is $1.00 and the share price is $10.00, then the dividend yield is 10%.
The dividend yield should be broken down further before making an investment. Take a look at the annual dividend in comparison to the annual earnings. A dividend that is less than the annual earnings is what you want to see, because the earnings are covering the payout.
Then, take a look at future projected earnings of the company to ensure that the earnings can cover the dividend. This provides more certainty regarding whether the dividend can continue.
Mistake #4: Buying a Low-Price Stock
Often a big mistake is looking at a lower-priced stock over a higher-priced one; since more shares could be purchased. Whether you are looking at a $5.00, $20.00, or $100.00 stock; there is one number that makes the stock price not very important, and this is the total amount of capital you are investing.
For instance, if you have $10,000 to invest, it does not matter what the individual stock price is. The focus should be on growing this amount of capital that is invested in the stock over time. This is why looking at the big picture makes all the difference, and why the share price is not as important as you may think.
Mistake #5: Ignoring the Investment and Markets Completely
As noted above, research is necessary before making an investment, including learning about the current earnings, the dividend, and other data on the financial statements. Then, based on this information, you either buy the stock or you don’t. However, some people think this is all there is to investing. That is a mistake. Rather, you need to continue to assess the investment, even after the purchase.
First and foremost, continued monitoring is required to ensure that your personal goals are still aligned with those of the stock. This won’t require a lot of time, only needing to be done on a quarterly basis, when the company releases its earnings.
Think of reports on the company as a report card, giving insight into its past performance. Management should also offer forward guidance on what the next few quarters or years are going to look like, which is valuable information, to say the least. This info should prevent any surprises regarding the share price and dividend payment.
And if the company reports one or two bad quarters, it does not mean you should sell the shares right away. Rather, consider a long-term view of the company, as well as how well the stock is performing against the overall market. It is also important to compare the stock you own to its industry peers, specifically the historical returns and growth outlook. You should be able to answer why the stock is underperforming or overperforming versus the industry and/or overall market. The answer may even change your future outlook on the company.
Mistake #6: Ignoring the Future
While an investment is always made in the present (duh), the returns are always generated in the future. So, while it is important to look at the company as it is now to ensure it meets your needs, you need to also consider where the growth is going to come from.
This growth would be from the current business operations, investments into new business segments, and/or acquisitions. This information is key, since growth will impact the business and shareholders alike.
Mistake #7: Holding a Poorly Performing Stock
Whether you have a few years of investing experience or many years of knowledge, I can almost guarantee that you have experienced losing money on a stock. After all, as this list proves, there are more than enough mistakes that new investors make.
When owning a stock with a negative return, your portfolio results will differ greatly over the long term from one with positive returns alone. Just how big a difference will come down to when you choose to cut your losses and move on to another investment.
Investors who see positive overall returns over a long-term period will take a hard look at why an investment is negative and, based on what they find, will either keep the shares—believing that things will get better—or get rid of them. On the other hand, investors who hold on to a negative investment without learning why are making a huge mistake, potentially seeing the stock drop further. There is also the risk of wasting time in the company; time which could have been spent seeing a positive return elsewhere.
Mistake #8: Staying Away from Low Liquidity
One number that is often overlooked, which has nothing to do with the dividend and the stock price, is the stock’s volume. This is the number of shares that are traded on a given day.
Why is it important? Well, the volume informs investors of how easy or hard it is to trade the stock. A stock with a large number of shares being traded would be the desired investment type. This is because it will make adding or removing the position within your portfolio very easy.
In contrast, if a company does not have a lot of stock trading volume, it could mean that the shares have to be bought and sold at unfavorable prices. It would also be difficult to get into and out of a position. This is not positive, especially if you need to raise money for another investment opportunity in a short time.
What you should do is look at the daily volume and compare it to average volume over the past month. The expectation is that the daily volume is somewhere around the average volume. The great thing about this is that the necessary information is known before the money is poured into the stock. This should give you an idea of how things will pan out when you sell the shares.
Here is an example of what to look for. Let’s say you want to purchase 10,000 shares of a company, and only 2,000 shares trade a day. That means the complete trade would take about five days. This would show evidence of how hard it is to get in and out of the position, and of the need for patience. But, if there were a million shares traded in a day, it would be very simple to get in and out of the position.
Mistake #9: Making Decisions Based on Taxes and Expenses
An investment decision should be based on expenses if it is going to fulfill your investment goals, be they income needs, capital growth and preservation, or improving allowable risk tolerance. Many investors tend to forget this, and make decisions based on a trade’s commission costs, holding a position that is no longer suitable. Yes, this will cost you some money in expenses but, if the investment does not fit into your investment criteria, it is best to get rid of the position.
Another reason that investors hold on to a stock longer than expected is the tax liability that may be incurred. If you are earning a dividend, this would be taxed either way. And, if you want to sell one dividend stock and own another for more growth potential, the tax rate would be the same, regardless.
Selling a stock at a higher price than first purchased means a capital gain, part of which would have to be paid to the government. But, if there is no future growth in the stock, then it may remain flat or see a negative return.
That means this hypothetical stock does not meet the investment goal of preserving the capital investment. Therefore, regardless of whether you sell the shares today or in a year’s time, you would have to pay taxes. If you sell the shares, the capital could be used to purchase shares in another company that expects a higher growth rate.
Mistake #10: Looking at Historical Returns Rather Than Future Expectations
Investors tend to hear or look at the past returns of a stock and expect the same growth rate going forward. If a stock has generated double-digit returns in the past, that does not mean that the same returns in the future are guaranteed. The only time when past performance truly matters is when you’re looking at how the company has performed against its industry peers and the overall market (as explained earlier). Otherwise, the focus should be on how your capital in the stock and dividend income can grow.
Final Thoughts About Dividend Investing
Going through these 10 mistakes that dividend investors make should help make your investment decisions easier, as well as make the process of looking for new investments more enjoyable.
You may sometimes be doing something that does not benefit you, but you don’t realize it until someone else points it out. Based on my personal experience in investing and working for large investment firms, I have learned these lessons firsthand. I hope the preceding information helps you get better returns from your investment portfolio, and that you dodge common dividend investing mistakes.