You know what you want to do. You want to build up a passive income stream by following a dividend investing strategy.
When you’re starting out, you want to build your income up fast and get that dividend snowball rolling early on. Naturally, your attention turns to the high yield dividend stocks, those companies paying out over 5% in dividends.
While that’s not a bad idea, there is a safer and better way to build your portfolio for the long term.
You need to use a mix of different dividend stocks: low, average, and high yielders with low, average or high dividend growth rates. They all have their benefits and drawbacks, and they all play a part in your dividend portfolio.
Read on to find out more.
- Three Types of Dividend Growth Stocks
- Dividend Portfolio Mixture
- Types of Dividend Stocks Over 20 Years: Example
- Three Types of Dividend Growth Stocks Conclusion
- Types of Dividend Growth Stocks FAQs
Three Types of Dividend Growth Stocks
1. Low Yield, High Dividend Growth
A low yield dividend stock has a starting dividend yield of less than 2%. However, these stocks tend to grow their dividends by around 8-10% per year to account for the low yield.
Low yield stocks have one drawback which is the income they provide initially will be smaller than the income produced by average or high yielding stocks.
However, the dividend payout ratios of these companies will typically be in the 20-40% range, meaning that they have a lot of room to grow their dividend. That means there is a lower risk of a dividend cut even if the company has a few years of poor performance.
Since these companies are more growth-oriented, they plow a lot of their earnings into the business. For that reason, these stocks should appreciate in price more than slower growing dividend stocks.
2. Average Yield, Average Dividend Growth
Depending on your financial goals and your time horizon, most of the stocks in your dividend portfolio should fall into this category. This category features companies with a starting dividend yield between 2.5% to 4.5% and a dividend growth rate between 5-8% per year.
These companies will be the steadiest and most stable stocks in your portfolio. Although none of these types of stocks will help you get rich quickly, these are the ones that will help you sleep soundly at night.
3. High Yield, Low Dividend Growth
High yielding dividend stocks are companies with a dividend north of 5%. The dividend may only grow at a rate of 2-5% per year, if that.
When the dividend yield gets up into this range, you need to think about why the yield is so high. After all, high-yielding dividend stocks will only grow their dividends minimally in most cases.
You can find quality stocks in the 5% yield range, but you have to look at the dividend payout ratios to ensure that there is enough room for the dividend to keep growing.
Dividend Portfolio Mixture
So how can a mixture of the three types of dividend growth stocks help you?
Well, the low yielders offer you greater opportunities for price appreciation and given enough time (several decades) they can become your biggest producers of dividends in your portfolio.
It may not seem like it at the start given their extremely low dividend rates, but the compounding effect works wonders. You will see this in an example later.
Low-yielding stocks have very low payout ratios usually, which translates into greater dividend safety because there is a lot of room for dividend growth.
The average yield, moderating dividend growth stocks should form the core of your portfolio because they are the tried and tested blue-chip mature companies. They are steady and dependable.
To build wealth with dividends, you need to keep investing for a long time. These types of stocks will help you sleep easily at night because they tend to have lower levels of volatitly especially when the market is crashing.
High-yielding but low dividend growth stocks give you that initial income boost which can carry your portfolio for a long while. They provide you with initial income and help motivate you when you’re in the early phases of your dividend investing career. The high yielders help build your intial dividend snowball and give you confidence in your plan.
Remember that these companies typically have higher payout ratios and are growing slower than the other two types of dividend stocks. Dividend safety may also come into question if the company has a few poor quarters.
Let’s look at an example to see how these three types of dividend growth stocks fare over 20 years.
Types of Dividend Stocks Over 20 Years: Example
The table below shows you what to expect in terms of dividend growth from purchasing 100 shares of a $50 stock depending on which of the three types of dividend growth stocks you decide to purchase.
For this example, the initial investment is $5,000. No other capital will be invested and dividends are not reinvested.
Remember, a company announces dividends each year. It requires no action from you.
In the “Low Yield” scenario, you start with a yield of 2% and the company raises their dividend by 10% per year.
In the “Avg. Yield” scenario you start with a 3% yield and the company grows the dividend at 6% per year.
In the “High Yield” scenario you have a beginning yield of 5% and then experience a dividend growth rate of 3%.
Let’s see how much you receive in dividends after 20 years from each type of dividend growth stock.
|Year||Low Yield (2% Yield, 10% Div Growth)||Low Dividends Annually||Avg Yield (3% Yield, 6% Div Growth)||Avg Dividends Annually||High Yield (5% Yield, 3% Div Growth)||High Dividends Annually|
|1||2.00%||$ 100.00||3.00%||$ 150.00||5.00%||$ 250.00|
|2||2.20%||$ 110.00||3.18%||$ 159.00||5.15%||$ 257.50|
|3||2.42%||$ 121.00||3.37%||$ 168.54||5.30%||$ 265.23|
|4||2.66%||$ 133.10||3.57%||$ 178.65||5.46%||$ 273.18|
|5||2.93%||$ 146.41||3.79%||$ 189.37||5.63%||$ 281.38|
|6||3.22%||$ 161.05||4.01%||$ 200.73||5.80%||$ 289.82|
|7||3.54%||$ 177.16||4.26%||$ 212.78||5.97%||$ 298.51|
|8||3.90%||$ 194.87||4.51%||$ 225.54||6.15%||$ 307.47|
|9||4.29%||$ 214.36||4.78%||$ 239.08||6.33%||$ 316.69|
|10||4.72%||$ 235.79||5.07%||$ 253.42||6.52%||$ 326.19|
|11||5.19%||$ 259.37||5.37%||$ 268.63||6.72%||$ 335.98|
|12||5.71%||$ 285.31||5.69%||$ 284.74||6.92%||$ 346.06|
|13||6.28%||$ 313.84||6.04%||$ 301.83||7.13%||$ 356.44|
|14||6.90%||$ 345.23||6.40%||$ 319.94||7.34%||$ 367.13|
|15||7.59%||$ 379.75||6.78%||$ 339.14||7.56%||$ 378.15|
|16||8.35%||$ 417.72||7.19%||$ 359.48||7.79%||$ 389.49|
|17||9.19%||$ 459.50||7.62%||$ 381.05||8.02%||$ 401.18|
|18||10.11%||$ 505.45||8.08%||$ 403.92||8.26%||$ 413.21|
|19||11.12%||$ 555.99||8.56%||$ 428.15||8.51%||$ 425.61|
|20||12.23%||$ 611.59||9.08%||$ 453.84||8.77%||$ 438.38|
In the low starting yield scenario, you begin at a 2% yield. The high yearly dividend growth rate of 10% increases your dividend fairly quickly. By Year 15 you start to generate more dividends annually ($380) from the “Low Yield” scenario than from any other scenario. That is the power of dividend compounding.
If your time horizon is 15 years +, a good option would be to include some low initial yielders. The bonus is that low-yielding but high dividend growth stocks will generally offer more capital appreciation over time.
By year 19, the average dividend yield growth stocks begin to pay out more ($428) in dividends annually than the high initial yield but low growth dividend stocks ($425).
Overall, though, through 20 years you would still receive more total dividends from the “high yield” stocks. We can attribute this to the huge income production advantage these stocks had for the first 12 years over the other dividend growers.
By year 24, the low yielders would overtake the high yielders in terms of overall dividends and never look back (not shown in the chart, but it is an interesting tidbit).
You’ll notice that in each scenario the dividends you received over the 20 years was higher than the initial $5,000 you invested into the stock originally. That is spectacular.
Want to hear another cool thing?
In this example, you did not add a single dollar to any of these stocks. The companies raised the dividends each year, and you did nothing. Just held onto the stocks.
Want to hear an even cooler fact? This chart only shows dividend returns. Dividend growth stocks offer two ways to make money: through dividends and stock price appreciation.
You won’t know what the price of a stock will be in two weeks, let alone 20 years, but dividend growth is a factor in driving prices up, long-term. So there probably will be capital appreciation to add to the dividend returns.
Three Types of Dividend Growth Stocks Conclusion
Now that you know about the three types of dividend growth stocks, you should aim to have a mix of them in your dividend growth portfolio. Remember if your time horizon is 25 years or more you should aim to have a lot of low yield but high dividend growth stocks on your team.
Do you favour having high yielding but low dividend growth stocks, low yielding but high dividend growth stocks, or average yielding and average dividend growth stocks in your portfoilo? Let us know in the comment section below.
Types of Dividend Growth Stocks FAQs
What are dividend growth stocks?
Dividend growth stocks raise dividends annually, increasing your income without you having to do anything. These are generally mature, well-established and dominant companies that want to reward shareholders each year. These companies balance paying out dividends, reinvesting in the business, paying down debt and increasing its cash account.
What are the types of dividend growth stocks?
There are: 1. Low yielders with high dividend growth rates 2. Average yielders with average dividend growth rates 3. High yielders with low dividend growth rates.
A diverse portfolio will have a mix of all three types of dividend growth stocks.
How much do I need to invest to make $500 a month in dividends?
You will need $200,000 earning a dividend yield of 3% annually to make $6,000 annually, or $500 per month in dividends. That’s if you do a lump sum investment.
If you have been dividend growth investing for a long time you will need considerably less as the companies you invest in will raise their dividends each year without you doing anything.
If you want to up your dividend investing knowledge, here are some important articles to check out.
- Learn all about dividends with the ultimate dividend guide (blog post)
- Find out more about the importance of dividend growth rate (blog post)
- Learn all about researching dividend growth stocks (blog post)
- Find out about dividend reinvestment plans (blog post)
- Discover the advantages of dividend growth investing (blog post)