There are two types of dividend investors out there: yield grabbers and growth groupies. But the most successful dividend income investors I know capture both.
Income-hungry investors aren’t satisfied with receiving a paltry 2% dividend yield.
That’s why many investors gravitate toward high-yield dividend stocks. For the sake of this argument, I’ll define high-yield stocks as those with yields greater than 4%.
I call these investors “yield grabbers.” They’re looking to cash a big dividend check right now.
Telecommunication and utility companies, master limited partnerships, and real estate investment trusts often have high yields. They also have slower dividend growth.
These companies and the products or services they provide are often natural monopolies. Some examples of natural monopolies are oil and gas pipelines, telephone lines, and internet connectivity. But often, government regulation or other factors limit profit and dividend growth.
But not all high-yield stocks make good investments. Some of them are downright dangerous.
We call these stocks “yield traps” because the companies are in trouble. They have high debt loads and declining sales, and they cannot afford to keep paying their lofty dividends for long.
Yield trap dividends are unsustainable and make horrible investments. If you invest in these stocks, you’re likely to lose money in two ways. The first is an income hit when the company cuts or eliminates its dividend to preserve cash. The second is a principal hit as the price of the stock continues to fall with the company’s declining business performance.
Yield grabbers must be experts at spotting and steering clear of yield traps if they want to build a lasting dividend income stream.
But avoiding yield traps doesn’t guarantee that yield grabbers will have enough to get by in the future.
While higher income today is great, it’s also important to have much higher income tomorrow. Unfortunately, most high-yielding stocks don’t fit that bill.
Typically, high-yielding stocks have slower distribution growth. They raise their dividends just a few percentage points each year. Some high-yield stocks haven’t raised their dividends in years (if ever).
Yield grabbers usually dismiss low-yielding stocks. They often won’t invest in a dividend stock with a yield below 2.5% or 3%.
It’s understandable in some cases.
Low-yielding stocks don’t generate enough income right now for yield grabbers. If you’re in or near retirement and are depending on dividends to pay your everyday bills, a paltry 1% to 2% yield doesn’t cut it.
But here’s the good thing about some lower-yielding stocks…
As the chart shows, they typically grow their dividends at a much faster pace than their high-yield counterparts. Some lower-yielding stocks even double their dividends every single year! This is especially true of new dividend payers.
That’s why growth groupies love them.
You can blame it on the law of small numbers. If the dividend is small to begin with, even a tiny increase will be a big percentage gain.
Let me show you how it works…
A $0.05 raise on a $0.05 dividend means that the company increased its payout by 100%. That doubles your yield on your cost basis if the number of shares you own stays the same.
(As a refresher, yield on cost is calculated by dividing the current annual dividend by the price you paid for the stock.)
Higher-yielding stocks, on the other hand, often have larger dividends in terms of dollar amounts.
That same $0.05 bump on a $1 dividend means that the company increased its payout by just 5%. In this case, you get a lot less bang for your invested bucks and may actually lose spendable dividend income as inflation rises.
But recently, The Oxford Club’s Chief Income Strategist Marc Lichtenfeld discovered a strategy that makes yield grabbers and growth groupies happy.
He’s found the best and fastest track to enormous dividend yields and returns.
Marc has identified a select group of stocks that pay what he calls “Extreme Dividends.”
Extreme Dividends are dividends that rise so high and so fast that they wind up paying you more than your initial investment every year. On the chart above, imagine a line shooting straight up. That would show the trend of these Extreme Dividends.
Arlington Asset Investment Corp. (NYSE: AI) is one example of an Extreme Dividend.
The company increased its dividend so fast that a $5,000 investment began paying out $7,945 in dividends every year to investors.
That’s a 158% yield on your cost basis!
Arlington Asset is just one of many Extreme Dividends that Marc has uncovered.
Owning just a few Extreme Dividend stocks could easily replace the income from a full-time job!
When it comes to dividend investing, you don’t have to choose between the two most profitable strategies. You can have both!
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Source: Investment U