How to Manage Risk Using Dividend Stocks: Build your Portfolio


The stock market is a risky place. If you do not understand how to manage the risks, you could end up losing money or in some cases, you could be extremely lucky. With that said, using dividend stocks is a great way to manage your risk. If you are wondering how, well, that is what we are going to take a look at in this article.

You use dividend stocks to protect your downside, so the quarterly or annual payments from your shares are used to offset any losses made. If you plan your portfolio accordingly, you can gain an income from dividend stocks while experimenting with more risky speculative stocks.

In this article, we are going to start off by being very specific. We are going to talk about how to use dividend stocks to manage risks while building your portfolio. We will then move on to how you can manage risk in general and finally, we will talk a little bit more about dividend stocks in general. So, keep reading!

Manage Risk with Dividends 900x900

4 Ways to use Dividend Stocks To Help Manage Risk

A lot of successful investors use dividend stocks to manage their risks. They know how to “play the market”. Managing risk does not mean not taking any at all. A more accurate description would be, it prevents your losses from cutting too much into your profits.

That is why in this section, I am going to break down how using dividend stocks helps you manage your risk in the stock market. I will try my best to break each point down into its own sections. I will then go in-depth into why it helps you when it comes to risk.

I speak to a lot of investors who are just starting out. I also speak to a lot of people who want to get started out in the market and there are small details that either they miss when speaking to other people, or they simply don’t get told this information.

So, a beginning investor might have a few misconceptions when it comes to how dividend stocks work.

#1. Use Dividends To Make Up For Losses Incurred

When you get paid out a dividend, they are not paying you back on your investment. They are just giving you a percentage of the current value of each share that you own of a stock. Dividends are generally paid out every quarter. The value of your stock does not go down when they pay you a dividend.

The value of your stock will still be relative to how the market is doing. So, if you get paid out dividends for 10 years and each share that you own within a certain stock is the exact same value as when you bought it, you will get paid out that same amount that you invested. So, all of those dividends are profit. You can think of it as being paid interest for your investment.

Some of the best investors use these dividends to make up four losses they may have incurred via a different stock. I like to see this as playing the market.

Knowing that every quarter you will be able to make up for your losses will allow you to set a small portion of money aside to take a little bit more risk with. We will get into that in the next section.

#2. Allows For More Freedom If You Have Extra Cash

I want you to imagine a scenario where you have investments in two different stocks that each pay out dividends. You are also looking at a few different stocks that seem slightly risky, like a high yield stock.

If after doing all of your recommended research, you determine that this stock could yield significant returns for you, you could simply invest slightly more than what your dividend will pay you out each year. Or simply re-invest your dividend which a feature on Trading 212, or eToro.

Don’t worry, because if you have invested in stable dividend stocks, the value of those should remain stagnant or keep going up at least. So, that should not be an issue.

However, in terms of the risky stock, you don’t need to worry about short term price movements up or down unless your losses are more than your dividend payments for the year.

See, at the end of the day, that is literally called managing your risks. If you are prepared to lose some money, make sure that it is less money than what you are going to make in a year. That is good risk management.

#3. Reinvest Your Dividends Into Riskier Stocks

Similar to the last section, you could reinvest your dividends into other stable stocks or you can take slight risks with them. When we say take a risk, we don’t mean just go out there and invest in any stock that you see that promises you a high yield. You still need to do your research just to make sure that if you do lose, you don’t lose more than what you have made.

If you are confident that your current safe dividend stocks are going to keep increasing in value, you will still end up making a profit and you could use your dividend money to start reinvesting. This is where I say, taking slight risks could be worth it.

#4. Most Dividend Stocks are Reliable

Most stocks that offer dividend payments are relatively stable. When you look at companies such as Apple, American Express, and many more, their stock prices keep increasing year after year. They do react to major market shifts like the rest, but by being long standing established dividend payers, they tend to bounce back quite quickly.

Not only will you be getting paid out a percentage of your initial investment every quarter or every six months, but you can also know that when it comes time for you to sell your shares, you would have probably made a profit. But you could also keep your shares for as long as the company offers dividends.

This profit obviously depends on how the stock prices of the company performs within the time that you held your shares. The longer you hold onto a safe dividend-paying stock the more profit you earn through dividend, and based on past performance, the more the market will grow.

How To Manage Risk When Investing

In this section, we will still speak about dividend stocks quite a lot and how they can be used to manage your risk. However, a large portion of the information in the section will be on how to invest safely and in a way where you can minimize the amount of risk you are taking.

Let’s get into it.

Never Invest Through Emotion

One thing that I have noticed with beginner investors is they tend to invest in companies that they are familiar with or companies that have attachments to.

Another thing I see is when a stock offers a high dividend they might quickly start imagining that they will be able to quit their jobs with those kinds of returns. Think of it as dreaming.

The truth is if you feel like you want to invest in a stock almost right away without doing much research simply because someone told you that it is a good stock, be cautious. If you want to invest because you have an emotional attachment to the brand or because you saw dollar signs flashing in front of your eyes, don’t do it. Take your time and do your homework.

I think it’s better if I say, make sure you know what you are doing before you jump into investing in stocks.

High-yield Dividend Stocks Need To Be Scrutinised

Because we are talking about managing risk while using dividend stocks, I think it is important that we start off by saying that you should never fall for the trap. Yes, sometimes high yield dividend stocks will offer you the world, but they might be hiding something.

I am not saying that they are all bad, there is one scenario that I can think of where they will offer a higher dividend for good reasons. However, there are more scenarios that are negative that I can imagine when it comes to companies offering such high returns.

Here are a few possible reasons why a company would be offering a high yield dividend for each of their stocks.

  • They are in financial trouble.
  • Current investors are pulling out. 
  • The company is no longer competitive and is forecasting a market drop.
  • They are looking to grow and will slash dividends in the long run. This is a positive reason. When a company is looking to grow and they have a good track record, there is less risk.

If a company offers high yield dividend stocks, the first thing you want to do is to go through their financial history and their current financial state. This is because while a company can come back from financial difficulties, there is a chance that during this time, they lose their competitive edge.

Unfortunately a company that offers a high dividend yield can often find themselves spending money they don’t have. If the company can’t afford to pay the high dividends to investors, they will have to start diving into savings and therefore increase debt.

One way to find out if a company can afford to pay its dividend is by looking at the payout ratio.

Do Your Research

My fear with this article is that a bunch of people are going to just go and invest in the first dividend stock that they see. This is very dangerous, remember, you want to do your research. 

It bothers me when I am trying to find something out and I see people make blanket statements like the one I just made. So, to be as thorough as possible, here is a list of things that you can do when doing your research on a company

  • Check the value of their stock dating back at least 1 and a half years.
  • Look for any news regarding the company.
  • Try to see what services or products they have in store for the future.
  • Check their competition. You can apply all of the same methods.
  • Sometimes, a company might not be transparent so you want to do research on its employees starting from the highest positions.
  • Finally, you want to take into account the current global climate.

You can also take advantage of our Stock Picker Checklist to find solid dividend paying companies. You can read our article to find out how to use it.

Keep Up To Date With The Market

Ok, so you have invested in a stable dividend stock and everything is going perfectly. You have received a few dividends and you are happy. Now is not the time to lose focus. You need to check up on the stock market every day and you need to especially check on the stocks that you are invested in.

It is very rare for a stock to plummet to the point where you lose everything, well, at least this is true for the majority companies on major exchanges.

However, nobody can predict the future and this is what makes investing in the stock market a risky business. Keeping track of your shares, the competition to the stock you own, current global affairs, and the stock market, in general, is a must. It will help you get out if you have to.

Diversify Your Portfolio With dividend Stocks

Diversifying your portfolio is one of the most important things you can do when investing.

One of the quickest ways to lose a lot of money is to put all of your eggs into one basket. Investing in different companies might mean that you have to work a little bit harder when doing your research. It also means that you have to work a little bit harder when keeping yourself updated with the stock market.

All of that will pay off in the end and if one stock drops and your other one thrives, it will cancel out the losses you incurred from the other one. Once the stock that took a hit rises again, you will be back to making a profit. You will be grateful that you diversified your portfolio.

How Long Do You Have To Hold A Stock To Get The Dividend?

Some companies might require you to hold a stock for at least 60 days in order for you to receive your first dividend. However, most companies stipulate how often they will make these dividend payments.

Generally, the company will only pay out dividends every 3 or 6 months. It is important that before buying the stock you research how often they pay these dividends. You should also research what percentage they payout.

A dividend stock will have an ex-dividend date, and a paying date. To ensure you receive your dividend for the current quarter, you must own the stock before the ex-dividend date passes.

When it comes to answering the question of how long you should hold onto a stock, I would say you should hold on to it for as long as the market price is stable or keeps rising.

That is if you don’t need the money. If you don’t, then there is no reason for you to cash in on your investment early. Rather keep getting those dividends and keep watching the share price of a stock rise, trust me it is a great feeling.

How Do You Know If A Stock Pays A Dividend

This is rather easy. All you have to do is research the company you are interested in and you want to look for their stock symbol on a page like Google finance. Near that symbol, you will see the name “dividend”. It will also tell you what percentage of a share value they payout.

Finally, you will also be able to see how often they make their dividend payments and the current amount they pay out per share.

One final thing to note is that Yahoo Finance is a great tool to use when researching dividends, they will send updates and news alerts about your ‘starred stocks’ just incase it is something important.

Conclusion

My goal with this article was to give you as much information as possible with a little bit of advice thrown into the mix as well. To beginners, the stock market can seem like a scary place but if you do enough research and you take certain precautions, it doesn’t have to be a scary place for you.

When it comes to building a portfolio, using dividend stocks to manage your risks and cancel out any losses that you incur makes for a great portfolio that could help you build a successful stock market experience.

Chris Race

I am an accountant from the U.K. specialising in Management Accounting, Personal & Business Tax, Financial Analysis, and Wealth Management. My passion for learning is what lead me to creating this blog. Stock market investing has always been a interest of mine, and since I was 18 years old... This interest has become a source of income for me and my family.

Recent Posts