10 Dividend Investing Mistakes to Avoid - dummies

10 Dividend Investing Mistakes to Avoid

By Lawrence Carrel

Here are some of the most common and serious dividend investing mistakes you can make; avoid them and eliminate some of the risk inherent in the world of investing.

Buying a stock solely on a hot tip

A hot tip is just that — a tip, an idea to follow up on. You still need to do your research, which means you should pull up the company’s quarterly statements over the past year or so, crunch the numbers, see whether any insiders are buying shares, and perhaps even speak with one of the company’s representatives (or at least your broker) to check on the company’s prospects moving forward.

Skipping your homework

Those who win the day are the investors who do their homework and keep a cool head when everyone else is losing theirs.

The best way to keep a cool head is to know what you own, what you’re buying, what you’re selling, and why. If you know you own well-managed companies that have a solid track record for growing sales, profits, and dividend payments, you’re less likely to get spooked when the market takes a dive. You can look for deals instead of looking for the exits.

Expecting to buy and sell shares just for the dividend

Wouldn’t it be great if you could buy a stock the day before the company is due to pay dividends, collect your dividend payment, and then sell the stock? On the surface, this strategy seems like a good way to beat the market, especially if the company has announced a big one-time dividend payout. Unfortunately, this clever trick doesn’t work.

Sure, you may be able to collect the dividend payment, but when you try to sell the stock the next day, you’ll be sorely disappointed. Share prices are reduced to reflect that dividend payout, and if you sell immediately after the dividend payment date, you pretty much break even.

Focusing solely on yield

When people start investing in dividend stocks, they automatically gravitate to the high-yield stocks. But depending on the industry, a high-yield stock can just as often be a sign of trouble as a sign of big profits. Don’t let yield blind you to a company’s growth prospects. Often, a company with a lower-than-average dividend that’s experiencing solid growth and consistently increasing its dividend may be a better choice than a company with a larger yield that’s currently in stagnation mode.

Don’t buy a stock simply because it has a high yield. Find out whether the yield is high because of high dividend payments, low share price, or both. Examine the company’s fundamentals as well as the broad market and economic environment. Perform additional research to ensure that the company is sound before you invest in it.

Focusing on current rather than future dividends

When you look up a stock’s dividend, you’re looking at its current dividend, which is like looking at yesterday’s news. It’s relevant because that’s what you get paid this year. But as an investor, you’re less interested in what the dividend’s paying now and more interested in its potential to grow in the future. Unfortunately, nobody has a crystal ball to reveal how much a company will pay in dividends in the future, but you can make an educated prediction by examining the following:

  • The company’s recent and long-term trend in raising dividends

  • Management’s income projections

  • Any significant developments that may alter the company’s past trend of free cash flow

You may be better off buying shares in a company that pays a lower dividend if the company shows a lot of potential for raising its dividend moving forward, rather than a high dividend that remains static.

Failing to monitor stocks and the market

Assuming you purchase stock in large, well-managed companies with a solid track record of paying dividends, you can sleep a little more soundly than most growth investors or Wall Street speculators. However, you shouldn’t fall asleep at the wheel. Even big companies can fail. Just look at Bear Stearns, Lehman Brothers, and Chrysler.

Always keep tabs on your money, the stocks you’ve purchased, and the news. If you’re open to hearing bad news, you can usually pick up on the warning signs before a massive sell-off. When you start hearing people in the know talking about impending bubbles, that’s usually a good sign that you need to perk up your ears and make exit plans. Focus your plans not only on reducing risk but also on taking advantage of new opportunities.

Buying a stock just because it’s cheap

Knowing the difference between a low share price and a good value is the difference between making and losing money. Just because a stock is cheap doesn’t mean it’s a bargain. Buying a stock just because it’s cheap isn’t investing. It’s speculating or betting.

To steer clear of this trap, carefully research a cheap stock’s company fundamentals. Unlike large and higher-priced stocks, you usually find very little other information about these low-priced companies. Companies that have a history of paying dividends are rarely cheap, but when they are, that’s a screaming buy. As long as you stick with the dividend investing model, you should be free of any temptation to buy a stock solely because it has a low share price.

Holding a poor-performing stock for too long

Letting go is tough, especially if you own stock in a company that’s performed well for you in the past or even one that experiences only short-lived highs. Waiting to sell until you get even is a loser’s strategy. On Wall Street, emotional attachments can be brutal, and hope can be your true enemy. If a company has experienced a serious setback and is losing market share, don’t let your emotions get in the way. Cut your losses, dump your shares, and find another place to invest your money.

Failing to account for taxes

Too many investors focus on the amount they stand to gain and don’t stop to think about how big a bite taxes can take out of that figure. Financial success isn’t necessarily based on how much money you earn. How much money you keep is what matters.

Regardless of where you put your money — stocks, bonds, real estate, CDs, money market funds, and so on — always consider the tax ramifications of your investment decisions. If you earn $200,000 and lose 35 percent in taxes, you walk away with $130,000. Pay only 15 percent in taxes, and you keep $170,000, or about 31 percent more. If you need to, talk to an accountant to develop a strategy that maximizes your after-tax returns. If the government decides to raise taxes on dividends to 30 percent, be prepared to adjust your strategy to take advantage of other investments with lower tax rates (if available, of course).

Giving too much credence to media reports and analysis

Financial newspapers and magazines, websites, and investment TV and radio shows are all excellent sources of information, but they’re not always right. That’s because they rely on information from company insiders. If investors learned anything from the meltdown in the financial sector in 2008, it’s that people lie and management isn’t always forthcoming about what’s going on in a company.

Don’t assume any single source is 100-percent reliable. A company’s financial documents are always the best source. Financial newspapers and their websites come second. But newspapers can make mistakes, too. Always verify the information by comparing it to other sources and your own instincts and insight.