The Problem with Relying Too Much on Dividend Income
It’s true that an income portfolio can be a good way to provide yourself with a stream of passive income that can support you in the future. However, it is important to be careful. If you rely too much on dividend income, you might wind up in a difficult situation.
Main Issue with Dividends
The main issue with dividends is that they can be cut – or even eliminated – at any time. Companies are not obligated to keep paying dividends. They can get rid of them suddenly, or cut them during tough economic times when cash gets scarce. As a result, if you are relying too heavily on dividends, you could find yourself facing a significant decrease in your income if the investments in your portfolio suddenly cut their dividends.
At this juncture, especially if you are retired, or don’t have other sources of income, you might be forced to sell some of your stocks. In some cases, this can be a very inconvenient time because the stock price might have dropped as well. So, you will be forced to sell your holdings in order to get the cash you need, but you won’t perhaps, get as good a return as you would have liked.
Protecting Your Income from Dividend Cuts
As a result of this possibility, it is important to protect yourself from dividend cuts. Many people think that you have to be either a total return person, or a dividend person. The truth, though, is that you can be both. You can create an investing plan that allows you to create a portfolio that allows you to build up, on the one hand, investments that you know you will likely sell at some point, as well as create a dividend portfolio that provides an income stream.
You can also protect yourself to some degree by choosing your dividend stocks carefully. Some investors like the dividend aristocrats because the companies involved have raised dividends every year for at least 25 years in a row. With dividend aristocrats, there is a smaller chance that the dividend will be cut, much less disappear altogether. Of course, the possibility of a dividend cut or elimination is always there, but it is smaller.
Diversify Your Portfolio
It is also possible to diversify your dividend portfolio so that you have different types of stocks involved. That way, if cuts are more sector-based, you will still have other investments that will hold up, and possibly help make up for a dividend cut.
And, of course, you can prepare your finances by building up an emergency fund of some sort. That way, if you end up the victim of dividend cuts, you can draw on your emergency fund while you wait for your dividend stream to recover, or wait for the markets to improve so you can sell some of your investments later. You can also start a side business, or cultivate some other source of income to help provide you with a stream if dividends are cut.
Being prepared with different options can help you avoid the problems related to dividend cuts, and better prepare you for a successful financial future.