Saturday, December 26, 2009

Are High Ratio Dividend Payout Stocks Make A Low Risk Investment? - Part 4

The idea behind All Dividend Income investing may sound low risks and logical.

But very often, these investors have forgotten about the serious impact of inflation and under-estimate the power of compounding returns to fight inflation.

Every year, inflation will reduce your real returns and erode the purchasing power of your original capital that was invested.

If you plan to derive your passive income in this way, then just how big an dividend income can you expect in going through this route?

It will take a real big account size to produce sufficient sum of dividends to be able to re-invest them for compounding effect. Furthermore, when the market is trending up, a pure dividend yield investors will find it more difficult to re-invest as the dividend yield will be falling as well.

Another serious consideration is the real purchasing power of your original capital after so many years. For example:

If the dividend yield is 10%, it will take 10 years to recover your orginal capital. But, after 10 years, what will happen to the real purchasing power of your original capital?

Worse still, if the dividend yield is only 5%, it will take 20 years to recover your original capital.

There's also no guarantee that the companies will be able to continue year-on-year to pay out good dividends. If companies start to struggle due to change of management or business environment it may cut or eliminate their dividends. When dividend yielding stocks fail to deliver, you can bet the stock price will plunge faster than expected and can remain at that level for a long time. By then the stock price could be down considerably and the inflationary impact may completely destroy the real purchasing power of your remaining or recovered capital.

The real enemy of any long term investor is inflation.

Do you seriously think that with an all dividend income strategy, you can really fight against your real enemy?

A reasonable strategy to fight against inflation is to include investing in some growth companies and also to periodically recover some invested capital together with their realized profits and to re-invest them to tap into the magical power of compounding effect to fight the real enemy.

1 comment:

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