Many investors enjoy gunning for growth (and capital gains) within their portfolios, and this is not surprising since these investors may be under the impression that equity portfolios are supposed to be predominantly geared for growth. While it is obviously not wrong to target growth and capital appreciation over time, investors should be aware that the total return for a portfolio generally comes from two major components: dividends and capital gains. Some studies even state that two-thirds of the total return can be attributed to dividends.
By turning your attention to dividends, you can shift your portfolio toward more income-focused investing. There are three clear benefits from this approach.
1. Regular cash inflows
The clearest benefit of an income-focused portfolio is the presence of regular and consistent cash inflows to supplement one’s existing income. For salaried employees, the dividends act as an additional layer of savings over and above what is already being saved, thereby boosting cash reserves in preparation for rainy days.
For retirees, these regular inflows represent vital cash flow to sustain one’s lifestyle and also cover future medical expenses. Having a healthy dividend flow gives you peace of mind to live the life you wish without feeling overly burdened by high expenses and costs.
2. Buffer during tough economic times
Companies that pay regular dividends are normally healthy businesses with strong internally-generated cash inflows and a healthy cash balance. This enables them to withstand tough economic conditions such as recessions and downturns, acting as a buffer for the portfolio. To be fair, an investor does need to do some homework to ensure that the business has the financial means to sail through a wild storm. But if the homework is done right, investors can enjoy a cushion of safety during periods of economic turmoil. Dividends may be reduced, but if a company remains strong and resilient, it should still be able to pay out a dividend of some kind.
3. Tax-exempt income
For dividends received from equity holdings, the income will be tax-exempt in the hands of the shareholder. This is one big benefit many aren’t aware of, or perhaps do not account for. Contrast this to rental income from owning real estate — the income has to be declared to tax authorities and will be added to one’s chargeable income for tax computation purposes.
The Foolish takeaway
With the above three benefits, it’s not difficult to see why an investor should start focusing more on dividends rather than become too fixated on capital gains.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.