The word “dividends” is probably one of the most often-used words in investing, and it almost always brings a smile to an investor’s face. This is because unlike capital gains, which may be uncertain and fleeting, dividends are a definite return that goes straight into an investor’s pocket.
Some companies have a track record of rewarding shareholders with consistent dividends over the years and can therefore likely be counted on to continue this tradition, barring unforeseen circumstances. Here are a few other reasons dividends are so attractive for investors.
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Dividends signal that a company is performing well
The ability to pay out dividends is a signal that the company you invested in is performing well and generating good free cash flow. Dividends can only be paid out of profit, so screening for companies that pay dividends weeds out underperforming and loss-making companies — in other words, poor investments.
Rewarding shareholders with dividends also signals management’s intention to share its success — distributing the fruits of the company’s labor — and it’s an affirmation that management is taking care of minority shareholders.
Dividends play an important role in compounding
The act of compounding one’s wealth involves “letting money work hard to generate even more money.” This involves a virtuous cycle of receiving dividends, ploughing them back into the stock market through the purchase of great companies, and then receiving even more dividends from these companies in future years. This continuous process of allowing money to generate even more money is what makes compounding so powerful that it has been described by Albert Einstein as being the “eighth wonder of the world.”
Dividends add to one’s cash flow
As one grows older, his ability to generate active income usually correspondingly declines. Singapore has a mandatory retirement age of 62 years old, and though some people may want to work beyond this age, not everyone has the energy to, or to handle work-related stress. Dividends are able to supplement your cash flow by providing a passive form of income as you grow older, freeing you to pursue other interests.
In addition, if you are currently actively employed, dividends add to the total cash inflow of the family and allow you to build up your savings and tide over your budget in emergencies.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.