The Pros and Cons of Investing for Dividends
Today I’m looking at investing for dividends. This is an increasingly popular strategy among investors seeking to generate passive income while potentially also growing their capital.
Dividend stocks can provide a steady income stream, but they also come with risks and considerations. So I’ll begin by looking at the pros and cons of this approach. I will set out some hints and tips for anyone who may be interested in getting started at dividend investing. I will also mention some established UK companies that have a reputation for paying regular dividends, and some online share-dealing platforms that may be suitable for anyone applying this strategy.
Let’s begin with some of the attractions of dividend investing, though…
Pros
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Regular Income Stream
One of the biggest benefits of dividend investing is receiving regular cash payments, typically every quarter or six months, though occasionally monthly. This can be particularly appealing for retirees or anyone seeking passive income.
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Potential for Long-Term Growth
Many well-established companies that pay dividends also experience share price growth. Reinvesting dividends through a dividend reinvestment plan (DRIP) can compound returns over time.
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Stability in Market Downturns
Dividend-paying companies are often large, well-established firms that can weather economic downturns better than smaller, high-growth companies. Investors may find these stocks less volatile.
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Tax Efficiency for UK Investors
UK investors benefit from the £500 dividend allowance (as of 2024/25) before dividend income is taxed. Additionally, holding dividend stocks in an ISA (Individual Savings Account) or SIPP (Self-Invested Personal Pension) shields the income from tax altogether.
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Indication of a Strong Business
Companies that consistently pay and grow dividends often have strong financials, stable earnings, and a track record of profitability. This can be a sign of a well-managed company.
Cons
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Slower Growth Compared to High-Growth Stocks
Dividend stocks are typically in mature industries, meaning they may not offer the rapid price appreciation seen in high-growth technology or small-cap stocks.
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Dividends Are Not Guaranteed
A company can cut or suspend its dividend payments if it faces financial trouble, as seen during economic crises. This can lead to both income loss and share price declines.
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Dividend Tax for Higher Earners
If your dividend income exceeds the £500 tax-free allowance, you will pay 8.75% tax (basic rate), 33.75% (higher rate), or 39.35% (additional rate) on the excess amount. This reduces overall returns compared to capital gains, which have different tax rates.
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Sector Concentration Risk
Many high-dividend stocks are concentrated in certain industries, such as utilities, oil, and consumer goods. This can limit diversification and expose investors to sector-specific risks.
Tips for Beginners
If you’re new to dividend investing and want to try it, here are a few tips and guidelines to get you started…
Look for Dividend Growth, Not Just High Yields – A high yield can be a red flag if unsustainable. Instead, focus on companies with a history of gradually increasing dividends over time.
Diversify Your Portfolio – Don’t put all your money into one or two high-dividend stocks. Consider spreading investments across different sectors.
Check the Dividend Cover Ratio – This metric (earnings per share divided by dividends per share) shows whether a company can afford its dividend. A ratio above 1.5 is generally considered safe.
Use Dividend Reinvestment – Reinvesting dividends can significantly increase long-term returns through compounding. Many brokers and online share-dealing platforms offer automatic reinvestment options.
Consider Dividend-Focused Funds – If picking individual stocks feels overwhelming, dividend ETFs or investment trusts like City of London Investment Trust (CTY) and Murray Income Trust (MUT) provide diversification and professional management.
Examples of Strong Dividend-Paying UK Companies
Here are some UK companies known for consistent dividend payments in recent years.
Unilever (ULVR) – A consumer goods giant with a strong dividend history and steady growth.
Legal & General (LGEN) – A leading financial services company offering an attractive dividend yield.
National Grid (NG) – A stable utility company known for reliable dividend payouts.
BP (BP) – A major oil company that has historically paid strong dividends, though with some fluctuations.
Diageo (DGE) – A global leader in alcoholic beverages with a track record of dividend growth.
Online Share Dealing Platforms
Here are three UK share dealing platforms that are well-suited for dividend investors looking for relatively low costs.
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Interactive Investor (ii)
- Flat-fee pricing model, which can be cost-effective for those with larger portfolios.
- Monthly plans start from £4.99, including a Stocks & Shares ISA.
- Offers one free trade per month, with additional trades at £5.99.
- Free regular investing option for cost-effective reinvestment of dividends.
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IWeb Share Dealing
- One-off account opening fee of £100, but no annual fees after that.
- Low-cost dealing with £5 per trade.
- Supports shares, funds, ETFs, and investment trusts.
- No regular investing feature, but good for long-term investors who trade occasionally.
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Trading 212
- Commission-free trading on UK and international stocks.
- Allows fractional share investing, which is great for reinvesting dividends.
- Offers an AutoInvest & Pies feature for automated investing and reinvesting.
- No monthly fees for basic accounts, though there are forex fees for currency conversion.
Each of these platforms has strengths depending on your investing style. Trading 212 (a personal favourite of mine) is great for beginners and low-cost investors; Interactive Investor suits those with larger portfolios; and IWeb is a solid, no-frills option for long-term dividend investors.
Closing Thoughts
Dividend investing can be a great way to generate passive income, but it requires careful stock selection and risk management.
By focusing on financially strong companies with sustainable dividends and using tax-efficient accounts, investors can make the most of this strategy.
If you’re looking for a regular income from your investments combined with the potential for long-term growth, dividend investments have the potential to play a valuable role in your investing portfolio..
- See also this guest post by my colleague Lewys Lew on his personal approach to dividend investing. Although it was published a while ago, there are still some useful tips to be gleaned from it.
PLEASE NOTE: I am not a qualified financial adviser and nothing in this article should be construed as personal financial advice. You should always do your own ‘due diligence’ before investing and seek professional advice if in any doubt how best to proceed. All investing carries a risk of loss.