How to start investing in dividend stocks

In the current low-interest-rate environment in which savings accounts are paying absolutely appalling rates of interest, many people are looking for new ways to boost their wealth. Dividend stocks, which often offer yields of 5% and higher, make up one asset class that has become popular.

Wondering how to start investing in dividend stocks? Here’s a look at a few different ways to get started. 

Funds that pay dividends

If you’re new to stock market investing and/or you only have a small amount to invest, a sensible strategy when it comes to getting started with dividend stocks is to invest in a fund that has exposure to dividend-paying companies and pays regular dividends to its investors. These are sometimes called ‘equity income’ funds.

This approach offers a number of advantages. Firstly, you won’t need to worry about picking stocks yourself as a professional fund manager will manage your money on your behalf. Secondly, your capital will be diversified over many different companies, lowering your overall risk. Third, a fund may be more economical compared to buying individual stocks (you’d have to pay a trading commission for each stock you buy).

Funds that pay dividends that I like include:

• TB Evenlode Income 

• Franklin UK Rising Dividends 

• Man GLG UK Income

All three are available on the Hargreaves Lansdown platform.

Investment trusts that pay dividends

Another similar option is investment trusts that are focused on dividend stocks. These are like funds and offer many of the same advantages, however, they are listed on the stock market, meaning you can buy and sell them like regular shares.

Dividend-focused investment trusts I like include:

• Murray Income Trust

• City of London Investment Trust

• Merchants Trust

Index funds that pay dividends

A third option is to invest in index funds that are focused on dividend stocks. The advantage of this kind of fund is that they are generally cheaper to own than regular funds and investment trusts because they are run by algorithms and not portfolio managers. On the downside, however, they can underperform the market at times.

Examples of dividend-focused index funds include:

• Vanguard FTSE UK Equity Income Index

• iShares UK Dividend ETF

Individual dividend stocks

Finally, if you have a larger amount of money to invest, you might want to consider picking individual dividend stocks yourself. The advantage of this approach is that you have more flexibility in terms of your investment choices. For example, if you want to focus on high-yield stocks like Royal Dutch Shell (6%+ yield) you can. Alternatively, if you want to focus on dividend-paying companies that have strong long-term growth prospects such as Diageo, you can do that too. Picking your own stocks can also be more cost-effective than investing in funds over the long run.

I will point out that when analysing dividend stocks, it’s important to look beyond the yield. You’ll want to pay attention to things like dividend coverage, dividend growth, revenue and earnings growth, and debt levels. It’s also important to diversify your money across many different companies across different sectors in order to lower your stock-specific risk. I’d recommend owning at least 20 different dividend stocks, in order to minimise portfolio risk.

Interested to learn more about dividend investing? You’ll find plenty of information on dividend stocks to buy at The Motley Fool UK.