Ten Myths About Dividend Stocks

Once you have your house in order, have checked to make sure you aren't falling into common pitfalls of investors...it is time to start picking investments. In this unstable and unpredictable market, one of the safer stock picks are blue chip companies that pay good dividends. Before you race out to buy your stocks, I thought looking at dividend Myths and Truths might be a good start.

This article by Lawrence Carrel appeared in the September edition of Canadian MoneySaver. To read more, go to Canadianmoneysaver.ca.

If you were to ask a stock market investor or analyst about dividend stocks, it may surprise you to find that you are encroaching on a touchy subject. Much like politics and religion, dividend stocks tend to illicit a heated debate among investors about who is right and who is wrong.

On one side are the cheerleaders who believe dividend stocks are the next best thing to free money. On the other are the naysayers who believe that dividend stocks are the next worst thing to a government takeover.

As is usually the case when people start taking sides, their radical beliefs are based on myths or misconceptions implanted in them by misinformation or someone else’s misdirected advice. The truth tends to lie somewhere in between. Only by stripping away some of the most common and influential myths is the truth revealed. For a more balanced view, read on for ten common myths about investing in dividend stocks.

Myth: Dividend investing is reserved for retirees.

Truth: Dividend investing is admittedly attractive for seniors, whose goals are typically capital preservation and income. Younger investors, however, can also benefit from a dividend investing model, even if it comprises only a portion of their portfolios.

Dividend investing isn’t a get-rich-quick strategy. It’s a great way to build wealth over the long term (which means you want to start when you’re young) to secure a steady cash flow for your retirement years. All affluent older investors were young once, and many of them followed a relatively conservative dividend investment strategy even then to build their wealth.

Myth: You can get better returns with growth stocks.

Truth: Although growth stocks may offer more in terms of share price appreciation, dividend stocks often make up the difference in dividend payments. Dividend stocks can see returns grow in three ways:

· Share prices can rise.

· Dividend payments can increase.

· Reinvested dividends can purchase more stock. More shares pay out more dollars in dividends, which you can then reinvest again, and increase the profits from capital appreciation.

When comparing growth and dividend stocks, compare their potential in terms of total return on investment. For the dividend stock, this means share price appreciation plus dividends. Sometimes, slow and steady really does win the race. Growth stocks may carry a higher potential for bigger returns, but they also carry a higher risk for bigger losses. If you do experience a loss, your other holdings need to perform that much better to make up the difference.

Myth: Dividend stocks are safe investments.

Truth: Investing is risky no matter how you slice it; the risk of losing money is always present. However, some investments, including dividend stocks, tend to be safer than others. In 2009, for example, financials and real estate, which had paid reliable dividends for some time, went into a tailspin.

Don’t put all your investment eggs in one basket. Even when investing in safer options, diversify to spread the risk among several sectors and among companies in the various industries you choose to invest in.

Myth: Companies that pay dividends will limit their growth. Truth: Growth investors often argue that companies paying dividends would be better off reinvesting that money to fuel their growth. Although the suggestion may be the case with some companies in certain situations, the reasoning is valid only if that money is well spent.

Companies that don’t pay dividends give managers unrestricted use of the profits. Corporate executives often make acquisitions or start projects more to boost their personal worth (through bonuses and reputation) than to boost shareholder value. Risky acquisitions outside the company’s main business often promise big results and just as often turn into money pits.

Meanwhile, a commitment to paying dividends keeps management honest. Knowing the company must generate a certain amount of cash flow per quarter to pay the dividends shareholders expect, tends to motivate management to manage effectively. In addition, paying dividends leaves management with less capital to squander on risky business ventures. As a result, management must evaluate prospective business ventures more carefully.

Some of the largest companies in the world pay dividends, and they didn’t start out big. They began from scratch and grew; many continue to post significant growth despite paying dividends.

Myth: Companies should always pay down debt before cutting dividend cheques.

Truth: Debt isn’t necessarily a bad thing, although excessive debt certainly is. Whether a company should pay down debt before cutting dividend cheques depends on the circumstances. If the company is buried in debt and struggling in a tough economy, paying down debt before paying dividends is not only a good idea but also an essential move to protect the company’s survival. If, on the other hand, the company carries a reasonable debt load and its other fundamentals are solid, continuing or even raising dividend payments sends a positive message to the market.

Before purchasing a dividend stock, carefully inspect the company’s quarterly reports and take a close look at the quick ratio. The quick ratio indicates whether the company’s current assets are sufficient to cover its liabilities. The break-even point is a quick ratio of one, which usually means the company can afford to cover its liabilities, including its declared dividend payout. Anything less than one may mean that the company needs to borrow money to pay dividends, which is a bad sign.

Myth: Companies must maintain a stable dividend payout.

Truth: Companies are not obliged to pay dividends or to keep the payment stable after they start. However, dividend cuts tend to reflect poorly on a company and its share price, so companies tend to be conservative in establishing a dividend policy. Companies protect themselves by choosing a dividend payment method that allows them to manage shareholder expectations:

• Residual - With the residual approach, the company funds any new projects out of equity it generates internally and pays dividends only after meeting the capital requirements of these projects. In other words, investors receive a cut of the profits only if money is left over at the end of the quarter. Knowing this, investors are less likely to sell their shares if they don’t receive a dividend payment for a particular quarter because they know the next quarter may still bring a dividend.

• Stability - A stability approach sets the dividend at a fixed number, typically a fraction of quarterly or annual earnings, called a payout ratio. This gives investors a greater level of certainty that they’ll receive a dividend payment and how much it’s likely to be. Companies that implement a stable dividend payment approach tend to make conservative projections so that they don’t disappoint shareholders.

• Hybrid - The hybrid approach is a combination of the residual and stability approaches. Companies that follow this approach tend to set a low, fixed dividend that they feel is easy to sustain and then distribute additional dividends when they can afford to do so.

Myth: My dividend increases won’t even keep up with inflation.

Truth: Some companies’ dividend increases do in fact fail to keep pace with inflation. Your goal as a dividend investor is to ensure that the dividend payments from companies you invest in at least keep up with inflation and hopefully exceed the inflation rate. If you’re a growth investor looking for income, don’t dump a stock just because dividend payments aren’t keeping pace with inflation. Look at the stock’s total return, including share price appreciation, and continue to monitor the company’s fundamentals and the market at large. If the company is doing well, especially in a tough market, it may have the potential to raise dividend payments sometime in the future and perform well for you.

Myth: All dividends are taxed at the same rate.

Truth: Dividend investing fell out of favor in the 20th century because of unfavorable dividend taxation. A major reason for the resurgence of dividend investing was the lowering of the tax rate on dividends.

Myth: You should always invest in high-yield stocks.

Truth: Don’t judge a stock by yield alone. Yield is a valuable measure of how much bang you’re getting for each of your investment bucks, but it alone doesn’t determine a stock’s true value; you also need to look at the share price. You can use a minimum yield to screen out stocks that don’t meet your income requirements, but carefully evaluate a company’s fundamentals before investing in it.

A high yield can mean many things – some positive, some negative. High yield may be a sign that the company’s share price is sinking and that the company may be in trouble. If the high yield is out of whack with its sector, that may be a sign of an impending dividend cut. By the same token, don’t immediately write off low-yield stocks.

Myth: REITs and bank stocks are no longer good for dividends.

Truth: Two major factors that contributed to the fiscal crisis of 2008-2009 were a housing bubble that pushed the prices of real estate properties to astronomical heights and banks that approved mortgage loans for borrowers who couldn’t afford the payments. Not surprisingly, real estate investment trusts (REITs) and bank stocks, traditionally big dividend payers, were some of the hardest hit in the stock market crash of 2008-2009.

With little cash to pay their obligations, many REITs and banks were forced to cut or eliminate their dividends. However, a few strong companies continued to pay out dividends and even raise payments because they took less risk and managed their debt well. As many investors write off all of these companies in one fell swoop, now is the time to look for bargains among the healthy survivors.

Conclusion

Investing in dividend stocks is one of the top strategies to survive market instability, and you shouldn’t let misconceptions and myths hold you back from getting in on the action. Once you know the truth, you’ll be well on your way to adding dividend stocks to your own investing portfolio and making the most of your investments – in any market.

Top Ten Investor Mistakes

Once you have a budget and plan in place, you will start to notice that your funds available for investment will increase. Before we dive into the investment world, I thought it might be a good idea to look at the top ten mistakes that investors make which I found on the Alberta Securities Commission website and in a local article published in the Money section of the Calgary Herald.

1. DESTINATION UNKNOWN
Are you planning for retirement, buying a house or
saving for your child’s education? Different goals may
require different investment strategies. Failing to plan is
planning to fail.

2. BEING SHORT SIGHTED
Investing is a long-term process. Attempting to buy and
sell with perfect timing is not only impossible - it can
also cost you a lot of money. Long-term strategies may
not make you a millionaire overnight, but they won’t
bankrupt you either.

3. BUY FIRST-LEARN LATER
Investing first, then learning about your investment, is
putting the cart before the horse. The results can be
hard to swallow. Check First- there are many sources
of information to help you learn about the investing
process and specific investment vehicles.

4. THERE'S NOTHING TO IT
If it were possible to consistently beat the market,
analysts and brokers would all be millionaires (they
aren’t). Don’t overestimate your abilities or those of your
adviser.

5. TOO MUCH OF ONE OR TOO LITTLE OF EVERYTHING
Trying to eliminate risk by choosing too many investments can destroy opportunities for good returns.
Conversely, having too few investments or focusing on
one industry sector will significantly increase your risk.

6. FOLLOWING “HOT” STOCK TIPS
Building wealth takes time, patience, and discipline.
“Hot” tips are often from uninformed sources and based
on misinformation. By the time you get a tip, it’s often
too late and the opportunity has passed. NEVER buy a
stock based solely on a tip.

7. THE “I LIKE THEIR PRODUCTS” PHILOSOPHY
They may make your favourite beauty product, snack,
or vehicle, but that doesn’t mean they are a well-run,
profitable company. Research is the only way to find out
how good a company really is.

8. DOING THE WRONG THING AT THE WRONG TIME
Buy low. Sell high – it’s sage advice for making money.
If you have a good investment plan, there’s no need to
panic when markets fall. Spend the time to make a plan
and stick to it through the downturns – they’re often a
great time to buy rather than sell.

9.TAXES? WHAT TAXES?
Taxes play an important role in investment planning.
Different investments are taxed differently. Involve a
qualified professional to speak about Canadian taxation
in your financial planning process.

10. RISK? WHAT RISK?
There are many types of risk that can affect an
investment. Even guaranteed investments have some
risk. Your investment objectives will help you determine
how much risk you should take.

The Alberta Securities Exchange has lots of other resources to assist investors. I recommend you check it out by going to http://www.albertasecurities.com/Pages/Default.aspx.

Financial Literacy Step Two: The Plan

Once you have had time to think about your dreams, the next step in the process is developing a plan on how you are going to achieve your dreams. Your plan will consist of many steps but essentially it will involve setting up both your household finances and your investing habits to move you along your path to success.

The household finance step or better known as budgeting, is the first discipline that your plan should focus on. You will need to take a month to analyze where your money is coming from and where it is going. After this analyse, you are able to stream line your budget so that it is the most tax efficient while moving you towards achieving your dreams. Most financial experts agree that "Paying Yourself First" rule should always be in effect. Take a portion of the household money coming in and turn around and invest it by paying yourself before you pay anyone else. This will obviously need to be an amount that fits your budget but must be a consistent habit that occurs everytime you are paid.

The site http://www.bankrate.com/finance/financial-literacy/secrets-to-creating-a-budget-1.aspx clearly outlines the seven steps to creating a budget which I have posted below:

Indeed, budgets play a pivotal role in helping consumers pay off debt, feather their nest egg and make the most of their hard-earned dollars.
Yet, despite their best intentions, many Americans lack the money-management skills necessary to get their bank accounts under control. Why? Often, it's because they don't know where they stand, says Jim Tehan , a spokesman for Myvesta Foundation, a self-help consumer education Web site.

"People write out budgets all the time without knowing where their money is really going," he says. "What they've created is a wish list of how they'd like to spend their money, but it's not realistic. It's a page of lies."

Follow the money: Track your spending
The first step to developing a budget, says Tehan, is to track your expenses for at least a month, using a checkbook ledger, a sticky note inside your wallet or a Bankrate daily expense work sheet. Be sure to record every purchase no matter how small, including ATM fees.
"Once you know where your money is going, you can make an educated decision about how best to allocate your money," he says.

Many novice budgeters make the mistake of becoming too financially conservative, at least on paper.

"The No. 1 rule of setting budgets is to not cut all the fun out of your life. Inevitably, Spartan budgets that have no allowance for entertainment are doomed to fail."

Instead, learn to moderate. "If you're eating out every night, and that's something you enjoy doing, try eating out once a week instead," says Tehan. "It's not about cutting out everything that gives you joy in life. It's about better allocating your money."

Make savings contributions automatically
Though every budget scenario is different, Curt Weil, a Certified Financial Planner for the Lasecke Weil Wealth Advisory Group in Palo Alto, Calif., says a good rule of thumb is to allocate at least 10 percent of your earnings toward savings, using direct deposit to pay yourself first.
Tehan agrees. "If you put that money aside before you even see it, you won't miss it. Direct deposit helps to put your savings on autopilot."

Short-term savings that you may need to access can be held in an interest-bearing savings account, six-month certificate of deposit or money market fund. Long-term savings, meanwhile, should be directed toward a tax-friendly retirement savings tool, such as an individual retirement account, or IRA, or 401(k).

The ultimate goal, of course, is to maximize your RRSP , the maximum is $18,500 for 2010. But those just starting out should contribute at least enough to get the employer match, says Weil.

Define spending and priorities
Another 35 percent of your earnings, he says, should be earmarked for housing and utilities. Weil says, however, that homeowners can often up that percentage since principal payments are already a form of forced savings, and the mortgage interest they pay is tax-deductible.
If you're saving for something specific, such as a new car or your child's college education, you may want to set aside another 10 percent of your earnings into an interest-bearing account or a tax-favored 529 college savings plan.

Everything else-- the remaining 45 percent-- is discretionary, for use on food, entertainment, clothing and vacations.

That's where priorities come in. You can't have everything you want, says Martin Siesta, a Certified Financial Planner for Compass Wealth Management in Maplewood, N.J., but you can direct your dollars toward things you want the most.

"If consumers start by deciding what's most important to them, then cutting back on some of the things that aren't that important isn't really a sacrifice," he says.

Pay with cash
One you've determined how much to set aside for saving, spending and investing; it's time to make those numbers stick. The growing popularity of credit and debit cards makes it all too easy to overspend.
With the exception of your mortgage and car loan, most consumers should implement a strict policy of paying with cash for groceries, clothes, vacations and nonessential items.

advertisementSiesta also recommends relying less on ATMs, especially those that charge a fee. Withdrawing a fixed amount of discretionary money at the beginning of the month, he says, forces you to make better spending choices.

"By spending cash out of an envelope you begin to get a better feeling for where your money is going and what your priorities really are."

Strategically pay down expensive debt
Financially speaking, of course, you'll never get ahead if you don't also implement a plan to pay down your debt. Interest payments made to credit cards not only cost you big, but also deny you the ability to apply that money toward savings or entertainment.
"I approach it from an investment point of view," says Weil. "Not having to pay interest is the same, economically, as earning interest. So not having to pay credit card interest is like earning 18 percent."

According to Myvesta Foundation, the average American carries $2,328 in credit card debt, spread out over 2.9 cards.

Conventional wisdom maintains that consumers with multiple credit card balances should tackle the card with the highest interest rate first, while continuing to make minimum payments on their other cards. Once the first card is paid off, focus on the next highest rate card.

Tehan contends, however, some debt-laden consumers get a psychological boost by paying off the smaller balances first. "Paying off your highest rate card first makes sense because it saves you the most money, but if you have several smaller cards it can be easier psychologically to get those out of the way first. That way you can see some immediate progress, which gives you a little boost," says Tehan.

The secret to paying off debt is to determine how much you can afford to send each month and make those payments consistently.

"It's important to keep sending the maximum amount you can afford to send," says Tehan. "Some people make the mistake of reducing the amount they send when they see their payments going down."

Build a safety net
No matter what your debt situation, you should also begin saving for a rainy day.
Financial planners recommend setting aside three- to six-months' worth of living expenses into an emergency fund, in case you or your spouse lose a job, fall ill or get hit with an unexpected bill.

"It's important to set aside savings while you're paying off debt," says Tehan. "It may sound backward, but if you don't have an emergency account and you pay down your credit cards for six months and then an emergency pops up, all the progress you have made is going to be instantly wiped out."

The most painless way to save, of course, is to set aside any financial windfalls you receive, such as bonuses, tax refunds or yearly raises. You could also try saving your change or any $1 bills that find their way into your wallet.

Live within your means
Learning to live within your means is a simple matter of spending less than you make. For most consumers, that means cutting back. It does not mean doing without.
According to Siesta, there are dozens of ways to reduce your monthly expenses without crimping your lifestyle.

And above all else, stop trying to keep up with the Joneses. Your neighbors with the latest clothes and luxury cars may be drowning in debt, and while you may not sport a designer watch, you will be able to sleep at night.

"Being in control of your finances not only saves you money, but it also makes you a more financially secure person and family," says Tehan.

Financial Literacy Step One: Having a Dream

The famous quote by Martin Luther King, "I have a dream.." should be the first part of everyone's financial plan. King's dream was the vision that provided him guidance and reassurance when things were not going well. The markets will have ups and downs as will your life, so having a dream will keep you on your path towards where you want to be.

The dream also acts as your rationale for all of the other steps in your financial literacy plan. Some of the steps will not be easy to do and will test your will power. Having a strong rationale will prevent you from swaying off course. Your dreams should be clear and specific. They need to be shared with your family and friends and then this way they can support you as you move along your path.

Possible dreams could be to retire by the age of 55 so that you are young enough to truly enjoy retirement. Others may include: developing passive income streams to pay you while you sleep, travel to exotic places in the world, build a cottage on the lake or start a dream business. Achieving your dreams will essentially be the essence or the true test on whether you have developed your financial literacy to the fullest.

Financial Literacy Series

As many of you have known, developing my own financial literacy has been one of my passions over the last few years. I am now embarking on my own blogging mission to uncover as much information and share it with whoever will listen on this very important topic.

To begin, I thought a good starting point would be to look at the definition of financial literacy. According to http://www.financialliteracyincanada.com/eng/about-financial-literacy/definition.php; The Canadian Task force on Financial Literacy defines financial literacy as having the knowledge, skills and confidence to make responsible financial decisions.

•“ Knowledge ” means understanding personal and broader financial matters.
•“ Skills ” are the ability to apply that knowledge in everyday life.
•“ Confidence ” means feeling self-assured enough to make important decisions. This is often a key factor in galvanizing people into action.
•By “ responsible financial decisions ,” we mean that people will be able to use the knowledge, skills and confidence they have gained to make choices that are appropriate to their own circumstances.

Barely a day goes by that Canadians do not have to make a financial decision of some kind or other. Some decisions are routine, such as what groceries to buy or whether to pay by cash or by credit card. However, others are more momentous, such as deciding to open a savings account, or to go away to college or university or to take out a first mortgage.

To make decisions, people draw on their existing knowledge in a particular situation and apply it in such a way that is appropriate to their circumstances.

My goal over the next few months will be to assist people in the educational component of financial literacy. I believe this fits well with our mission as a club and will also assist me in developing a deeper understanding on all topics related to financial literacy. I will be using various sources to support the content but strongly encourage participation and comments on each blog post. Some of the topics that I will touch on include: Saving Money, Using Credit, Mortgages, Insurance, Investing and Estate Planning.

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