If your goal is to build a lot of wealth, then it's important to actively come up with an investment strategy that lends to that. And a big part of your personal strategy might hinge on buying dividend stocks.
Dividend stocks make a lot of sense on the one hand. That's because they not only pay you through the years but also have the potential to gain value over time.
But are dividend stocks the best choice for you? Or are you better off focusing your investing strategy elsewhere?
The upside of dividend stocks
Many people look to dividend stocks as a source of supplemental income. Seniors, for example, can cash out their dividend payments and use them to supplement their Social Security benefits.
But a big thing that makes dividend stocks so valuable is the cash they give you for investing purposes. While you're working, rather than cash out those dividends, you can use them to grow your portfolio. Through the years, that could result in a lot of wealth.
The downside of dividend stocks
Companies that pay dividends choose to share the wealth, so to speak, with their stockholders. That may seem like a great thing at first. But reading between the lines, when companies pay dividends, it means they're not pumping the money they distribute back into the business. And that could lead to stunted growth — and limited share price appreciation.
The latter is an important thing because if you buy a stock with the intent to hold it for several decades, your hope should be that your shares end up being worth a whole lot more than what you paid for them. If you load up on dividend stocks, you may find that your shares don't grow at the pace you'd like them to.
Furthermore, dividends can be deceptive — namely, they can give investors a false sense of security about a company's financial well-being. You might assume that a company with a generous dividend yield is in great shape. But that's not always the case, and it's important to make that distinction.
Should you focus on dividend stocks?
Dividend stocks could be your ticket to accumulating wealth. But rather than fixate on dividends, you may instead want to focus on businesses with a lot of growth potential, some of which might happen to pay a modest dividend along the way.
If you are going to center your investing strategy on dividend stocks, you may want to specifically look at real estate investment trusts (REITs). REITs are actually required to pay 90% of their taxable income to shareholders as dividends, and that means they commonly pay higher dividends than your typical company.
But again, don't just chase REITs with the highest dividends. Instead, focus on adding quality companies to your portfolio that do a good job of managing their cash. And also, don't assume that buying a REIT will mean getting a large stream of dividends. Some REITs have dividends that aren't much to write home about, so do your research to avoid ending up disappointed.
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