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Why Investors Need To Diversify Their Dividend Income, And How They Can Do It

Avoid getting all your dividend income from just one or two companies.

 

Most investors have two main objectives when it comes to investing. Growth and income.

Growth investing is when investors aim to invest in assets that will appreciate in value over time. The objective is simple. Find undervalued companies and invest in them today in the hopes that their value will become higher tomorrow. Thematic Investing, which we have written about previously, is one example of growth investing.

The other reason for investing is to enjoy passive income. Retirees and those who are no longer working will be able to relate to this. Investments are made into assets that are able to generate a regular stream of income for investors.

This income is important especially if investors are reliant on it. You can read more about how you can squeeze your stock portfolio for more income.

Read Also: 4 Different Kind Of Portfolios That You Should Know About

Diversifying Your Dividend Income

While the need to diversify across different industries is fairly well-accepted when it comes to growth investing, the concept isn’t as frequently discussed about when it comes to dividend income.

For example, it’s not uncommon to find dividend income investors in Singapore having the bulk of their portfolio in just telecommunication and property stocks. Or retirees who are reliant on just a handful of high-paying dividend stocks to fund their retirement. Yet by not diversifying their source of dividend income, investors could put their own income stream at risk.

Here are some areas that dividend income investors should look out for.

Look Beyond Dividends Payout And Towards Dividend Payout Sustainability

It’s easy to be attracted by companies that pay the highest dividends. Investors may assume the “best” companies are the ones that give the highest dividend yield. Under such an analysis, a company that gives a dividend yield of 5% is considered “better” than another company that is giving a 3% yield.

This is a simplistic and dangerous way to analyse companies. A high-paying dividend company is only valuable if 1) it’s profitable enough to generate free cashflow to continue sustaining the high dividend payout and 2) for some reason, its share price does not increase, despite its high dividend payout, thus allowing it to remain a high dividend yield stock.

If you were sharp enough, you would know that the two statements are somewhat contradictory. A profitable company that can sustain its divided payout is unlikely to remain undervalued for long, unless there are underlying concerns about it.

One such example that we previously wrote about was StarHub, which had to cut its dividend payout by 20% in 2017 due to concerns over its profitability.  This isn’t to say that StarHub is a bad company to own (it isn’t), but that investors cannot blindly invest into companies expecting them to sustain their dividend payout when it was already dipping into its cash reserve to fund its dividends.

So what are some simple ways dividend-seeking investors can do to diversify their risk?

#1 Diversify Within Sectors

If you like a particular sector because of the high dividends it pays out, do not simply go for one or two companies in the sector.

One such example is Singapore Real Estate Investment Trusts (S-REITs). Investors love S-REITs because of the attractive dividends they pay out. In our recap of how S-REITs performed in 2016, you can see that it’s common to find REITs giving yield of more than 6% per annum, up towards double digit numbers. You can also see how S-REITs are faring for 2017 so far.

One obvious strategy here is to spread out your risk within the sectors by choosing different types of REITs.

Read Also: 7 Types of REITS In Singapore, And The Reasons Why People Invest In Them

#2 Diversifying Across Sectors

Diversifying should not be restricted to companies within the same sector but also across different sectors. This ensures that your entire portfolio wouldn’t be at risk if one sector does collapse.

An example would be the oil and gas sector from 2015 to 2016. Due to falling oil prices, many oil and gas companies saw their share prices declining with a few shutting down operations completely. Investors who investing only in that sector would have seen a large chunk of their portfolio wiped out.

We are not saying that you should deliberately diversify your portfolio to include sectors that are not even giving out dividends. You shouldn’t be blindly invest in technology or biomedical companies just for the sake of it. However, you should consider investing in at least a few sectors where you can enjoy both dividend payouts and the benefit of diversification.

#3 Investing Outside Of Singapore

Investing in companies outside of Singapore is an option for savvier investors who want to further diversify their risk away from Singapore.

Aside from Singapore, developed markets such as Hong Kong, Taiwan and Japan also offer a good selection of dividend-paying stocks for investors to consider. The key here is to be able to understand these markets well enough such that you can make good selections that will improve your portfolio.

Read Also: How Singaporeans Can Start Investing In Overseas Market

#4 Consider Other Investment Instruments  

Last but certainly not least, if your objective is to generate passive income, then it’s worth considering other asset classes such as bonds, properties or even annuity plans.

All of these other instruments can provide alternative streams of income. They have varying levels of risk and may require different levels of understanding (for bonds and properties) and involvement (for properties). However, there is no reason why you shouldn’t invest in them for passive income once you are comfortable with it.

Care About Where Your Income Comes From

To conclude, it’s worth reminding ourselves that we shouldn’t just be fixated on how much dividend income we can get, but also the quality and sustainability of that income. We should invest only if we are confident that the income generated by these dividends are sustainable over the long-term. In addition, regardless of how confident we might be, we should always find ways to diversify our dividend income sources.

 

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