If you want to generate cash flow from your stock portfolio, you have to buy dividend stocks. These assets often give out dividends once per quarter, although there are a few stocks that give out monthly dividends.
However, receiving cash flow right now doesn’t necessarily mean you’re picking the best investment. One couple that’s worth $2.7 million recently shared that dividend investing isn’t the best strategy for young investors.
“Focusing on total returns is a more efficient strategy,” they explained.
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Here’s why that advice makes sense and what young dividend investors should consider before making any adjustments to their portfolios.
Focus On Total Returns
Young investors don’t have to rely on cash flow any time soon. While positive cash flow on a real estate property indicates that growth is scalable, it doesn’t have the same benefits for stock investors.
Some dividend investors chase high yields and end up with low total returns. For instance, Realty Income (NYSE:O) is a popular dividend stock since its yield is almost 6%. However, its stock price has been flat over the past five years. Meanwhile, tech companies with no dividends have more than doubled in value over the same period of time.
Dividend stocks make more sense when you need cash flow to cover living expenses and want to reduce your risk. Most companies that give out cash distributions to investors are mature companies that have their best growth days behind them.
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Dividends Get Taxed And Reduce Corporate Reinvestments
Another detail about dividends that makes them a less attractive strategy for young investors is that they get taxed. Most dividends are taxed at long-term capital gains tax rates, so it’s a better deal than ordinary income tax rates. However, you can avoid taxes on your stocks entirely by investing in reliable companies that don’t give out dividends.
Furthermore, dividends come from a company’s retained earnings. Giving cash to investors limits how much a company can reinvest back into itself. Amazon (NASDAQ:AMZN) regularly reinvested its profits back into the business, and those reinvestments helped Amazon launch Amazon Web Services, acquire Whole Foods and launch significant projects that boosted revenue.
Amazon still doesn’t give out dividends, and yet it has outperformed most dividend stocks over the past five years. If companies like Amazon gave out high yields, they wouldn’t have as much capital left over to reinvest in high-growth initiatives.
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Dividend Growth Stocks Are A Good Alternative
Some investors don’t want to give up on dividend investing as a whole, even if they recognize that they could get higher returns elsewhere. However, a good compromise is dividend growth investing, a strategy that prioritizes high dividend growth rates over the present yield.
Dividend growth stocks usually have yields that are close to 1%. While the present yield is low, many of these same companies hike the dividend by more than 10% per year. They can only deliver high dividend hikes because they report strong revenue and earnings growth.
Eventually, these companies will mature and offer high yields, especially if you compare the yield to your average cost basis. However, dividend growth investors can potentially log enticing long-term returns and have high cash flow when they need it.
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This article A $2.7 Million Couple Explains Why Young Investors Should Avoid Dividend Stocks: ‘Focusing On Total Returns Is A More Efficient Strategy’ originally appeared on Benzinga.com
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