Investing in the stock market can feel scary and more complicated than you’re ready to take on. One decision you’ll need to make is if you want to choose Dividend Stocks vs Index Funds, or maybe a mixture of both. Or maybe another type of investment.
I’ve owned stock and mutual funds since I was 5 (!) thanks to my parents that created UGMA accounts for me. When I turned 18 I decided to start investing in dividend stocks. Unfortunately my luck for the most part didn’t didn’t turn out as well as I hoped. So I wasn’t sure if I needed to change from focus between dividend stocks vs index funds.
At one point, I worked for a financial services company with a strict trading policy so investing primarily in index funds worked out better. That was until one day I looked at my dividend returns for the year. It was significantly down from the previous year, because the year saw a lot of market fluctuations. My assumption, which may be wrong, was that my returns were eaten by the extra trading by the fund management during a violative year. Looking at the holdings of the fund, the primary stocks were long-standing dividend payers so I expected better.
Feeling short changed, I switched to from index funds to primarily investing in the same dividend stocks the funds actually invested in. I decided to focus on a buy and hold strategy, which also keeps the expenses down.
Deciding between Dividend Stocks vs Index Funds
Let’s take a look at a Dividend Stocks
Dividend stocks, when chosen carefully can have a positive return on your investment portfolio. The company pays out a portion of it’s earnings back to the shareholders, usually quarterly. This is called a dividend.
If you reinvest those dividends automatically back into the same company, each quarter you’ll receive a slightly larger dividend, because you have a slightly larger number of shares. And if the company increases the payout per share, usually announced annually, you’ll also receive a slightly larger payout. Overtime, these slight increases snowball into larger quarterly and annual dividend payments.
The risk here is if you choose the wrong dividend stock, you may loose your investment if the company runs into trouble as far as declaring bankruptcy. When I choose a company to invest in, I’m looking at long standing companies with a history of paying dividends, such as the dividend kings, that were able to navigate through tough market conditions.
And now a quick look at Index Funds
Index Funds are portfolios of stock holdings that follow a preset set of rules that determine what to hold, when to buy, and when to sell. The positive here is that it doesn’t require much from you for tracking and management. here
There is where I think I saw trouble with my returns. In a year of a volatile marketing, I’m assuming that besides the individual company values fluctuated, there must have been extra buying/selling of shares. These extra expenses must have reduced the income from the fund to distribute.
Now don’t get me wrong. I’m not saying that index funds are bad, nor have I sold out from all of my fund holdings. Some are honestly better managed than others. I owned one fund for more than a decade, and it stayed at about the same value, even with reinvestment. On the flip side, I owned another fund that has done amazing well, and is currently valued multiple times the original investment.
Index Funds generally invest in many companies so the impact trouble with one of the investments won’t sink the entire fund. There a definitely pros and cons to investing in individual dividend stocks vs index funds. You’ll need to decide which works best for you, your portfolio, and your risk tolerance.
Why I decided to focus on Dividend Stocks vs Index Funds
I didn’t think I could successfully invest in individual dividend stocks. But once I realized that my returns on year were dismal, and in researching the funds, I recognized the companies held in the fund portfolios, I realized I could probably run my own portfolio. I wanted more control over the holdings, rather than delegate the decisions to a third party.
I should also note that I decided to recreate my portfolio in my IRA accounts, meaning I was not on the hook for capital gains taxes when I sold out from my mutual funds held in those accounts. For my taxable accounts, I’ve been more intentional about what I kept vs sold (that one fund with stagnant value was sold).
Over to you. What do you prefer? Dividend stocks vs Index funds. Or something else?
When you decided to create your self-directed investment fund, how did you choose your investments types? Has that changed over time? What are you thoughts on dividend stocks vs index funds?