Why You Should Be Cautious with Dividend Investing Right Now

Dividend investing is one of the more popular investment styles for people that aren’t necessarily looking for huge gains but rather passive income over time in the form of dividend payouts. It’s an attractive strategy because it allows investors to develop new income streams and experience compound growth over time. Dividend investing seems like a straightforward approach that can help you create real wealth over time. However, if you are interested in dividend investing, you need to understand the risks that are present in the market.

Many dividend investors will point to the fact that the yields on dividend stocks are much higher than anything you would get with a savings or money market account, but the yields don’t tell you the whole story. If anything, dividend investors should be more cautious than ever at this moment in time. That’s because dividend investing is a lot different when you are buying equities in a bear market versus a bull market. Let’s look at a few reasons why you should be extra cautious with dividend investing right now.

Companies Are Cutting Dividends

Dividend investing is often viewed as a conservative approach, but a lot depends on what types of companies you are buying and the economic environment you are buying them in. For example, the current economic woes and an impending recession will lead a lot of companies to cutting their dividend payments in order to weather the economic storm. There are plenty of businesses out there that simply are not able to earn money right now due to the pandemic. These companies will prioritize retaining their workforce, paying down short term debt, and keeping their operations going. If the company does not have a strong balance sheet, it will have no choice but to cut or reduce dividend payouts. This is one of the most important reasons why you should be cautious with dividend investing right now.

If you are chasing after high dividend yields or companies that have been beaten up over the last month and seem like a good deal, you need to take an in-depth look at the company’s balance sheet and financials before you invest. If a company does not have the cash to make it through this recession, you could be buying into a struggling company without the dividends you were anticipating. If you do want to put your money to work, buying dividend aristocrat stocks with stable Earnings Per Share growth can be a nice option because those companies have a long history of increasing dividend payouts. Just make sure you understand a company can’t pay a dividend if it is struggling to survive due to a recession or industry-specific risk.

Significant Market Downside Risk Present

People often look to dividend stocks as a “safe” place to park their money and generate passive income. That’s why you might be tempted to put some of your savings into dividend stocks at this time to capitalize on the yields. However, it’s crucial to understand the gravity of the situation that the economy and financial markets are facing. We are dealing with unprecedented scenarios with uncertain impacts. Although the Federal Reserve is rolling out massive stimulus packages, it’s important to understand that economic recessions occur gradually over time, not all at once.

The market might have reached a short-term bottom at this point, but the truth is that significant downside risk is still present. Jobless claims are higher than ever, we haven’t seen the full impact of the virus on company earnings, and the pandemic is not yet under control. Companies are cutting share buybacks and even issuing more shares as a means of generating cash to make it through the recession. These are significant risks for dividend stocks simply that cannot be ignored. Remember that share prices can decline even if a company continues to pay dividends.

Cautious Optimism

It can really pay off to exercise an abundance of caution when investing in dividend stocks at the moment. Dividend payouts are nice until you see the share prices start dropping or dividends getting cut. Until we have more clarity about the economic impact of the coronavirus and how long it will be affecting the global marketplace, it’s a good idea to stay extra safe with your dividend investment decisions. If you do decide to invest in dividend stocks, be careful with the businesses that you choose. Check for a strong balance sheet, consistent earnings growth, and consider whether or not a company’s business model will be able to survive the current economic downturn before you decide to invest.