1 Key Factor To Consider To Protect Your Stock Portfolio

Today, I would like to discuss the importance of a dividend yield in supporting your portfolio’s performance. Dividends can also play a role in providing an income stream for investors. For the avid reader following this conversation, today’s article is Part 5 of my series of articles on building a portfolio. You can catch the previous parts here: Part 1, Part 2, Part 3 and Part 4.

Setting the board

The dividend yield is defined as the absolute dividend per share (usually measured in dollars and cents per share) divided by the share price. As an example, if a stock’s dividend per share is $1 and its share price is $20, then the dividend yield would be 5% ($1 divided by $20).

Previously, I have written in another article on the importance of dividends and how they can contribute to overall returns for a portfolio. Companies which pay dividends are signalling that it i) has the ability to pay and ii) are willing to reward loyal shareholders. Both signs can be viewed as indicators of the management’s confidence in its business.

The downside to high yields

Dividends help to prop up a portfolio as it implies that the underlying companies must be generating good free cash flows in order to pay regularly.

However, investors should also note that if a stock’s dividend yield is abnormally high – say, above 8% – it may indicate that its dividends may not be sustainable. This scenario is based on my own personal experience whereby companies trading at high dividend yields either indicate the share price is declining (due to dimmer future prospects) or that the market is pricing in a high probability of a dividend cut.

Income in your pocket

A reasonable level for overall portfolio dividend yield would be in the range of 3% to 5%.

These dividends help to provide income into the investor’s pockets every few months so that he or she can use the cash to build up an emergency fund for rainy days or continue to reinvest these dividends to compound the returns on his or her investment portfolio.

Dividends are important as it functions as cash machines to provide the investor with passive income.

If a portfolio consists only of high-growth stocks which do not pay dividends, then there is nothing to “anchor” the portfolio when bad times arrive. Unlike dividend-paying companies, the stock market may not perceive such growth companies to be cash-rich or have the ability to generate consistent free cash flows.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.