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As an investor looking for income stocks, do you know what dividend yield is good?
Some people may get caught up with the highest yielding stocks, which may seem great at first glance. However, a company with a higher yield may not be a good investment at all.
Even though a company with a dividend yield of 8%, 9%, or 10% may seem like a great investment … that isn’t always the case. Actually, a yield that high is normally a “red flag” to many dividend investors.
So if the stocks with the highest yield don’t make good investments … which ones do?
What dividend yield is good when looking for stocks for your portfolio?
Let’s take a closer look at yields.
What Dividend Yield is Good?
There is no perfect answer to that question to be honest.
In some cases, a higher yield above 6% may be acceptable.
Other times, a low yield under 1% may be a good investment opportunity.
You see … there are different types of dividend paying stocks.
Some of these companies have been around a long time … and are not growing as fast as they once did. This doesn’t mean the company is bad … but rather they are in a different phase of business.
Then there are those companies who are still growing like crazy … and starting to pay a dividend.
It really depends on the type of company you are talking about when it comes to answering this question.
I prefer to break dividend paying stocks down into 4 major categories. The level of yield you can expect will differ depending on the type of dividend paying stock.
Below you will find a breakdown of the different types of dividend paying stocks. These are higher level categories of how I like to break down companies for our dividend stock portfolio.
1 – Buy and Hold Forever Stocks
This first group of companies are what many investors consider foundation stocks.
I like to refer to these as my stocks to buy and hold forever. Of course, nothing is guaranteed and I could one day sell a company in this category. But overall these are the companies that … you guessed it … build the “foundation” of your portfolio.
Most of the time (depending on the market), a company from this category has a dividend yield between 2.5% to 3.5%.
Buy and Hold Stocks – 2.5% to 3.5% dividend yield
These companies have probably been around for a long time too.
They grow their dividend by about 5% to 7% per year.
If you are driving down the road then you probably have seen a few of these companies. Or if you are shopping in a store, then you are buying their products.
A few of my foundation stocks include –
- Johnson & Johnson (JNJ)
- Procter & Gamble (PG)
- Clorox (CLX)
Some investors may consider these boring stocks, but they are as stable as they come. Which is why we build our portfolio from these companies with yields averaging around 3%.
2 – Growth Stocks
The next group of stocks are some of my favorite dividend paying companies.
When it comes to dividend growth stocks … most dividend yields will be below 2.0% … and in many cases below 1.0%!
Growth Stocks – 2% or less dividend yield
These companies are often overlooked as dividend income investments because of such low yields.
But the good thing about a company in this category is that they grow their dividend annually by more than other stocks. Often times these stocks will grow dividends each year by 10% or more.
So while you are giving up initial dividend income … you are more than making up for it in the future with growth.
A few of my favorite dividend growth stocks include –
- Micrsoft (MSFT)
- Apple (AAPL)
- Lowe’s (LOW)
And yes … Apple does pay a dividend and so does Microsoft! But you might miss these stocks in your search because both have yields (February 2021) under 1%.
3 – High Yield Stocks
Now we get to the category of companies where most new investors probably start … high yielding stocks.
Investing in the highest yielding stocks can be very, very tempting.
A company with a 10% yield for example, would provide an investor $10 back in cash for every $100 invested. With current interest rates on CD’s and savings accounts under 1% … the prospects of having a stock pay you back 10% is almost too good to be true.
I have invested in these types of stocks in the past … and most of the time it doesn’t end well.
I would caution investors to keep away from stocks like this … or at least do a deep dive into the company’s financials.
As a general rule of thumb … I try and look for dividend yields between 4% to 6% in this category. Although, I do currently own a few stocks (AT&T and Altria) that have yields currently over 7%. But I try and keep those holdings to a minimum.
High Yield Stocks – 4.0% to 6.0% dividend yield
A few of my favorite dividend growth stocks include –
- Consolidated Edison (ED)
- Verizon (VZ)
- AbbVie (ABBV)
Again … it can be exciting finding a company with a very high yield. But from my experience … most of the time these are risky investment options.
4 – Real Estate Investment Trusts (REITs)
The last category of stocks comes from Real Estate Investment Trusts or REIT.
A REIT is a company that owns and/or operates income producing real estate. By law, these companies are required to return a significant portion (90%) of taxable income back to shareholders in the form of dividends.
As a dividend income investor, I use REITs to diversify our portfolio into real estate … without actually buying any real estate. I am not interested in becoming a property manager anytime soon … so REIT investments give us exposure to real estate.
On top of the diversity they provide, a REIT can also improve your dividend income significantly.
Most real estate investment trusts that I invest in typically have dividend yields between 5% to 10%.
REITs – 5.0% to 10.0% dividend yield
The two REITs that we currently own are –
- Realty Income (O)
- Omega Healthcare Investors (OHI)
It is important to understand that these types of investments (REITs) operate differently than a traditional dividend stock. So looking at other metrics like dividend payout ratio are not as useful.
Keep this in mind when searching for stocks to add to your portfolio.
Building a Sustainable Dividend Income Portfolio
I think that every dividend income portfolio has a place for stocks in each of these four categories.
Because each type of income stock has different characteristics, it is difficult to say what dividend yield is good.
In some cases, a yield at 6% or more may be a good investment. While in other cases, a yield below 1% can also be a good investment opportunity.
When building a sustainable dividend income portfolio it is important to diversify across different sectors and types of stocks. If you find it difficult to do that, then a dividend ETF like the Vanguard High Dividend Yield ETF (VYM) may be a better option.
What dividend yield do you look for when picking stocks for your portfolio?
