Why dividend stocks could help you retire early

Dividend stocks retire early

Retiring early is a goal for many people. After all, life is simply too short to be chained to a desk forever. Could dividend stocks be the secret to an early retirement? Here’s three reasons they could be.

Dividends provide passive income

A dividend-paying company gives a portion of its earnings to its shareholders, in cash, on a regular basis. As a result, dividend stocks represent a very simple, effective way of creating a passive income stream.

With a diversified portfolio of high-quality dividend stocks, it’s possible to build an income stream that flows into your bank account month by month, year by year. Furthermore, with a dividend growth strategy, that income stream should grow at a healthy rate every year. That kind of passive income gives you powerful options in life, and could mean retiring early, or perhaps spending less time working and more time pursuing activities that you enjoy.

Dividends give you compounding power

Another significant benefit of dividend stocks, is the potential they provide for compounding.

Compounding is the process of generating earnings on an asset’s reinvested earnings, and results in the exponential growth of an investor’s capital. For this reason, compounding is a fundamental wealth-building concept.

As a dividend investor, it’s easy to put the power of compounding to work. Because you continually receive a stream of cash payments, this cash can simply be reinvested to purchase more securities. The end result is that more dividends will be generated for the future.

Dividends provide protection in bear markets

Rule No.1: Never lose money. Rule No.2: Never forget rule No.1. – Warren Buffett

When it comes to building wealth over a long-term investment horizon, preservation of capital is another extremely important concept. It’s also one that too many investors ignore, taking excessive risks in an attempt to build wealth quickly. But the fact is, if an investor loses 50% on an investment, they need to generate a 100% return just to break even. For this reason, preservation of capital is paramount.

This is where dividend stocks offer an advantage, as they can offer protection during bear markets and periods of market volatility. When market turbulence arises, as it so often does, investors generally gravitate to what they perceive to be the safest assets, and quickly move their capital out of riskier assets. Given that many dividend-paying companies are well established, mature companies with long-term track records, the ‘flight to quality’ often results in capital flowing into these blue-chip companies. Does that mean that dividend stocks won’t fall in a bear market? No – the chances are they will. However, history shows that dividend stocks often fall less than higher risk growth stocks, in times of panic.

With these three concepts in mind, I believe that high-quality dividend stocks could help many investors achieve their financial goals sooner. Early retirement may not be a pipe dream, after all.

This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

More from Edward Sheldon, CFA

ITV and WPP – Two FTSE 100 dividend stocks in the doghouse

In the last year, I have added both ITV (LON: ITV) and...
Read More

Leave a Reply

Your email address will not be published. Required fields are marked *