How and why create a dividend-yield-based stock portfolio?

Building a dividend yield-based stock portfolio is a popular investment strategy among investors seeking a combination of regular income and potential capital appreciation. However, like any investment strategy, it has advantages and disadvantages that need to be carefully considered.

Pros

1. Regular Passive Income
One of the key benefits of a dividend-yield-focused portfolio is the generation of regular passive income. Dividend-paying stocks provide periodic payments to shareholders, which can supplement the investor’s income or be reinvested to purchase additional shares.

2. Stability and Less Volatility
Companies that pay dividends tend to be more mature and financially stable. These companies often operate in established industries and generate steady cash flow, which can contribute to lower portfolio volatility than investments in high-growth companies that don’t pay dividends.

3. Potentially Greater Total Return
Investing in high dividend-yield stocks can improve your portfolio’s total return. In addition to potential capital appreciation, investors receive dividend payments, which can make up a significant portion of overall returns, especially in stagnant or declining markets.

4. Inflation Protection
Dividends can grow over time, providing some sort of protection against inflation. Many companies increase their dividends periodically, thereby increasing the investor’s dividend income and maintaining the purchasing power of the portfolio.

5. Business Discipline
Dividend-paying companies often exhibit stricter financial discipline. To maintain the ability to pay dividends regularly, they must effectively manage their operations, balance sheets, and growth strategies.

Cons

1. Limited Growth Potential
Companies that pay out a significant portion of their profits as dividends may have less capital available for growth investments. This may limit the potential for long-term capital appreciation compared to companies that reinvest their profits more.

2. Dividend Cut Risk
Dividend payments are not guaranteed. Companies may reduce or eliminate dividends in times of financial or economic distress. This may harm the investor’s income and share price.

3. Taxation of Dividends
Dividends are often subject to taxation, which can reduce an investor’s net return. While some jurisdictions offer preferential rates on qualified dividends, taxes can still represent a significant burden.

4. Sectoral Concentration
A portfolio focused on high-dividend-yield stocks may be overexposed to certain sectors, such as utilities, consumer goods, and financials, which traditionally offer high dividends. This sector concentration can increase the risk of the portfolio, making it less diversified.

5. Possible Security Illusion
High dividend yields can give a false sense of security. A high dividend yield could indicate underlying problems in the company, such as a significant drop in the share price or financial problems that could compromise the sustainability of the dividend itself.

Original article published on Money.it Italy 2024-07-01 07:59:00. Original title: Come e perché creare un portafoglio azionario basato sul dividend yield?