When it comes to investing in stocks, there’s no single way to analyze stocks to find a sure winner. That being said, there are many methods that ordinary investors can use to find stocks that are trading at a discount to their underlying value.
The first step in how to analyze a stock before buying is reviewing financial statements. From there, investors can use various methods of analysis to assess investment opportunities and potentially identify worthwhile investments.
Why Analyzing Stocks Is Important
The process of stock analysis can reveal important information about a company and its history, allowing investors to make more informed decisions about buying or selling stocks. Analyzing stocks can help investors identify which investment opportunities they believe will deliver strong returns. Further, stock analysis can assist investors in spotting potentially bad investments.
Whether you’re strategy involves short vs. long term investing, or day trading, analyzing stocks is going to be important
Understanding Financial Statements
The first step in understanding stock analysis is knowing the basics of business reporting. There are three main types of financial statements that an investor may need to look at when doing analysis:
• Income statement: This statement shows a company’s profits, which are calculated by subtracting expenses from revenue.
• Balance sheet: The balance sheet compares a company’s assets, liabilities, and stockholder equity.
• Statement of cash flows: This statement outlines how a company is spending and earning its money.
In addition to these statements, a company’s earnings report contains information that can be useful for doing qualitative analysis. The annual report includes the company’s plans for the future and stock value predictions.
4 Ways to Analyze a Stock
The next step in stock evaluation is deciding which type of analysis to do. Here’s a look at some of the different methods for how to analyze a stock.
1. Technical Analysis
Technical analysis is a method for analyzing stocks that looks directly at a stock’s supply and demand in order to make investing decisions. This form of analysis takes the stance that all information needed is present within stock charts and the analysis of history and trends.
Some key focal points of technical analysis are:
• Stock prices move in trends.
• History repeats itself.
• Stock price history can be used to make price predictions.
• Stock price contains all relevant information for making investing decisions.
• Technical analysis does not consider intrinsic value.
Trend indicators are one of the most important parts of technical analysis. These indicators attempt to show traders whether a stock will go up or down in value. Uptrends mean higher highs and higher lowers, whereas downtrends mean lower lows and lower highs. Some common trend tools include linear regression, parabolic SAR, MACD, and moving averages.
Technical analysis also uses leading indicators and lagging indicators. Leading indicators signal before new trends occur, while lagging indicators signal after a trend has ended. These indicators look at information such as volume, price, price movement, open, and close.
There can be some pros and cons to using technical analysis, however, which can be important to consider when factoring in your risk tolerance.
Day traders tend to focus on technical analysis to try to capitalize on short-term price fluctuations. But because technical analysis generally focuses on short-term fluctuations in price, it’s not as often used for finding long-term investment opportunities.
Further, while technical analysis relies on objective and consistent data, it can produce false signals, particularly during trading conditions that aren’t ideal. This method of analysis also fails to take into consideration key fundamentals about individual shares or the stock market.
2. Qualitative Stock Analysis
When considering how to analyze a stock, it’s also a good idea to look at whether the company behind the stock is really a good business. Qualitative analysis looks into factors like a company’s leadership team, product, and the overall industry it’s a part of.
A few key qualitative metrics to look at are:
• Competitive advantage: Does the company have a unique edge that will help it be successful in the long term? If a company has patents, a unique manufacturing method, or broad distribution, these can be positive competitive advantages.
• Business model: Analyzing a business model includes looking at products, services, brand identity, and customers to get a sense of what the company is offering.
• Strong leadership: Even a great idea and product can fail with poor management. Looking into the credentials of the CEO and top executives of a company can help in evaluating whether it’s a good investment.
• Industry trends: If an industry is struggling, or looks like it may in the future, an investor may decide not to invest in companies in that industry. On the other hand, new and growing industries may be better investments. This is not always the case, as there are strong companies in weak industries, and vice versa.
3. Quantitative Analysis
Similar to technical analysis, quantitative analysis looks at data and numbers in an attempt to predict future price movements. Specifically, quantitative analysis evaluates data, such as a company’s revenues, price-to-earnings ratio, and earnings-per-share ratio, and uses statistical modeling and mathematical techniques to predict a stock’s value.
The upside is that this financial data is publicly available, and it creates an objective, consistent starting point. It can help with identifying patterns, and it can be useful in assessing risk. However, it requires sifting through a lot of data. Further, there’s no certainty when it comes to patterns, which can change.
4. Fundamental Analysis
Fundamental analysis looks at a company from a basic financial standpoint. This gives investors a sense of the company’s financial health and whether its stock may be under- or overvalued. Fundamental analysis takes the stance that a company’s stock price doesn’t necessarily equate to its value.
There are a number of key tools for fundamental analysis that investors might want to familiarize themselves with and use to get a fuller picture of a stock.
Earnings Per Share (EPS)
One of the main goals for many investors is to buy into profitable companies. Earnings per share, or EPS, tells investors how much profit a company earns per each share of stock, and how much investors are benefiting from those earnings. Companies report EPS quarterly, and the figure is calculated by dividing a company’s net income, minus dividend payouts, by the number of outstanding shares.
Understanding earnings per share can give investors guidance on a stock’s potential movement. On a basic level, a high EPS is a good sign, but it’s especially important that a company shows a high or growing EPS over time. The reason for this is that a company might have a temporarily high EPS if they cut some expenses or sell off assets, but that wouldn’t be a good indicator of the actual profitability of their business.
Likewise, a negative EPS over time is an indicator that an investor may not want to buy a stock.
Revenue
While EPS relates directly to a company’s stock, revenue can show investors how well a company is doing outside the markets. Positive and increasing revenues are an indicator that a company is growing and expanding.
Some large companies, especially tech companies, have increasing revenues over time with a negative EPS because they continue to feed profits back into the growing business. These companies can see significant stock value increases despite their lack of profit.
One can also look at revenue growth, which tracks changes in revenue over time.
Price-to-earnings (P/E) Ratio
One of the most common methods of analyzing stocks is to look at the P/E ratio, which compares a company’s current stock price to its earnings per share. P/E is found by dividing the price of one share of a stock by its EPS. Generally, a lower P/E ratio is a good sign.
Using this ratio is a good way to compare different stocks. One can also compare an individual company’s P/E ratio with an index like the S&P 500 Index to get a sense of how the company is doing relative to the overall market.
The downside of P/E is that it doesn’t include growth.
Price-Earnings-Growth (PEG) Ratio
Since P/E doesn’t include growth, the PEG ratio is another popular tool for analyzing stocks and evaluating stock performance. To look at EPS and revenue together, investors can use the price-earnings-growth ratio, or PEG.
PEG is calculated by dividing a stock’s P/E by its projected 12-month forward revenue growth rate. In general, a PEG lower than 1 is a good sign, and a PEG higher than 2 indicates that a stock may be overpriced.
PEG can also be used to make predictions about the future. By looking at PEG for different time periods in the past, investors can make a more informed guess about what the stock may do next.
Price-to-Sales Ratio (P/S)
The P/S ratio compares a company’s stock price to its revenues. It’s found by dividing stock price by revenues. This can be useful when comparing competitors — if the P/S is low, it might be more advantageous to buy.
Debt-Equity Ratio
Although profits and revenue are important to look at, so is a company’s debt and its ability to pay it back. If a company goes into more and more debt in order to continue growing, and they’re unable to pay it back, it’s not a good sign.
Debt-equity ratio is found by dividing a company’s total liabilities (debt) by its shareholder equity. In general, a debt-equity ratio under 0.1 is a good sign, while a debt-equity ratio higher than 0.5 can be a red flag for the future.
Debt-to-EBITDA
Similar to debt-to-equity, debt-to-EBITDA measures the ability a company has to pay off its debts. EBITDA stands for earnings before interest, tax, depreciation, and amortization.
A high debt-to-EBITDA ratio indicates that a company has a high amount of debt that it may not be able to pay off.
Dividend Yield
While a stock’s price can vary significantly from day to day, dividend payments are a way that investors can earn a consistent amount of money each quarter or year. Not every company pays out dividends, but large, established companies sometimes pay out some of their earnings to shareholders rather than reinvesting the money into their business.
Dividend yield is calculated by dividing a company’s annual dividend payment by its share price. The average dividend yield for S&P 500 companies is around 2%.
One thing to note is that dividends are not guaranteed — companies can change their dividend amounts at any time. So if a company has a particularly high dividend yield, it may not stay that way.
Price-to-Book Ratio (P/B)
Price-to-book ratio, or P/B, compares a company’s stock market value to its book value. This is a useful tool for finding companies that are currently undervalued, meaning those that have a significant amount of growth but still relatively low stock prices.
P/B ratio is found by dividing the market price of a stock by the company’s book value of equity. The book value of equity is found by subtracting the company’s total liabilities from its assets.
Company Reports and Projections
When companies release quarterly and annual earnings reports, many of them include projections for upcoming revenue and EPS. These reports are a useful tool for investors to get a sense of a stock’s future. They can also affect stock price as other shareholders and investors will react to the news in the report.
Professional Analysis
Wall Street analysts regularly release reports about the overall stock market as well as individual companies and stocks. These reports include information such as 12-month targets, stock ratings, company comparisons, and financial projections. By reading multiple reports, investors may start to see common trends.
While analysts aren’t always correct and can’t predict global events that affect the markets, these reports can be a useful tool for investors. They can keep them up-to-date on any key happenings that may be on the horizon for particular companies. The information in the reports also can result in stock prices going up or down, since investors will react to the predictions.
Quantitative vs Qualitative Analysis
Here’s a quick rundown looking at the key differences between quantitative and qualitative analysis. Again, this can be important when weighing your risk need to knows as an investor.
Quantitative vs. Qualitative Analysis
Quantitative Analysis
Qualitative Analysis
Looks at data and numerical figures to predict price movements
Looks at business factors such as leadership, product, and industry
May require sifting through a lot of data, and may be difficult for some investors
Metrics include business models, competitive advantage, and industry trends
Concerned more with the “quantity” and hard data a business produces
Concerned more with the “quality” of a business
Pros and Cons of Doing Your Own Stock Analysis
If you feel like you can do a little stock analysis on your own, there are some pros and cons to it.
Pros
Perhaps the most obvious pro to doing your own stock analysis is that you don’t need to pay someone else to do it, you can do it on your own schedule, and learn as you go. You can develop knowledge that’ll likely help you as you continue to invest in the future. There are also numerous tools out there that you can use to analyze stocks which may not have been around in years or decades past.
Cons
Stock analysis can be an involved process, which can require a lot of investment in and of itself — both monetarily (if you’re using paid tools) and in terms of time. Depending on how deep you want to go, too, it can be a complex process. You may get frustrated or burnt out, or even make a mistake that leads to a bad investment decision.
Buying Stocks With SoFi
There are a number of ways to analyze stocks, including technical, fundamental, quantitative, and qualitative analysis. The more an investor gets comfortable with terms like P/E ratio and earnings reports, the more informed they can be before making any decisions. Stock analysis is an involved process, however, and may be above the typical investors’ head and ability.
It is important to do your research and homework in relation to your investments, however. If you feel like you could use some guidance or a helping hand, speaking with a financial professional is never really a bad idea.
Ready to invest in your goals? It’s easy to get started when you open an Active Invest account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
For a limited time, opening and funding an account gives you the opportunity to win up to $1,000 in the stock of your choice.
FAQ
What is the best way to analyze a stock?
There’s no “best” way to analyze stocks. The right option for an investor will depend on their personal preferences and investing objectives. And remember, there’s no need to just use one method to analyze a stock — often, analysts will combine different methods of analysis to generate a more robust stock analysis.
What are key indicators to look for when analyzing a stock?
There are a ton of potential indicators that investors can look at, but some broad indicators that investors can start with include stock price history, moving averages, a company’s competitive advantages, business models, and industry trends.
What is an example of stock analysis?
A very, very basic example of stock analysis would include looking at a stock’s share price, comparing it to its historical averages and moving averages, overall market conditions, and looking at the company’s financial statements to try and gauge where it might move next.
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Observing the current trends in the stock market has been challenging. The Federal Reserve is making moves to curb high inflation rates, and many financial experts concur that an economic downturn could be on the horizon.
Unsurprisingly, these developments have affected the market. Notable indices like the S&P 500, the Dow Jones Industrial Average, and the Nasdaq composite have experienced significant downturns.
In situations like this, it can be daunting to determine which stocks to invest in, if at all. Yet, even in an environment that feels like navigating through turbulent waters, there are promising opportunities to seize.
Best Stocks to Buy Right Now
When the bears take hold of the market, it’s easy to second-guess your investment decisions and difficult to find anything you’d be interested in piling your money into. However, no matter how red the market is, there’s always a glimmer of green.
Where are those glimmers now?
The top stocks to buy now are large companies with a massive economic moat — a competitive advantage that keeps competitors from chipping away at them. Many of these are non-cyclical plays that offer strong dividends. And there are a few cyclical gems that risk-tolerant investors may want to dive into for a discount on gains that seem all but guaranteed in the future.
Here are some ideas for the best stocks to consider buying right now. There’s a little something for every kind of investor. For more ideas, check out our list of the best stock picking services, including The Motley Fool Stock Advisor.
Best for the risk-tolerant investor.
Dividend Yield: 0%
Valuation Metrics: Price-to-earnings ratio (P/E ratio): ~30
Market Cap: ~$610 Billion
Tech stocks like Amazon are likely the last pick you’d expect to find on this list. The company operates in a highly cyclical industry and has given up about a third of its value this year alone. There’s no question that some AMZN investors are frustrated beyond words at this point, but that’s often the best time to buy.
Even through the recent selloff, the stock has maintained its position as a favorite among exchange-traded funds (ETFs) and mutual funds. What’s so exciting about this falling knife?
Amazon is an e-commerce giant with a clear ability to weather economic storms. The company’s share price didn’t even flinch in the face of the COVID-19 pandemic, likely because it benefited greatly from stay-at-home orders and store closures.
That’s not the first crisis the company has faced. Although it had its ups and downs, the company’s strong fundamentals carried it through the dot-com bubble burst and the Great Recession. And though the stock may be trading down at the moment, that trend isn’t likely to last forever.
If history is any indication, the company will be sailing toward all-time highs again in no time flat.
The company also has a potential bounce back to greatness as fears settle. Throughout the majority of its existence, Amazon has focused on razor-slim margins in the e-commerce space. However, its newer Amazon Web Services (AWS) cloud computing offering is anything but a thin-margin offering. Margins on the AWS business are so big that they’re pushing the company’s average margins to the roof.
All told, Amazon does face some economy-related headwinds ahead, but it’s nothing the company hasn’t already proven to be perfectly capable of handling. If you’re risk-tolerant enough to hold on through what may be a short-term rough patch and wise enough to dollar-cost average in the bear market, AMZN is a stock that’s worth your consideration.
2. Devon Energy Corp (NYSE: DVN)
Best for income investors.
Dividend Yield: ~9%.
Valuation Metrics: P/E ratio: ~5
Market Cap: ~$30 billion.
Devon Energy is an income investor’s dream. The company is the highest-paying dividend stock on the S&P 500. Devon Energy is an oil and gas powerhouse with a long history of stellar performance — and after more than 80% growth over the past year, the share price growth is expected to continue.
Income investing veterans may be thinking, “DVN is only paying dividends because oil and gas prices are soaring.” But that’s not the case. The company has consistently paid strong dividends to investors for the past 29 years, even when oil and gas prices have been down.
It has a strong balance sheet and impressive credit rating. Even when the oil and gas industry isn’t so hot, the company has access to the money it needs to pay dividends.
Now may be the best time to buy too.
The Organization of Petroleum Exporting Countries (OPEC), the world’s largest oil cartel, recently announced plans to boost oil production. The announcement sent DVN falling, giving up much of the gains it’s seen this year already. Although the stock is up 12% YTD, it’s given up more than 33% of its value in the past month.
These declines aren’t going to last forever.
European nations are expected to ban more than two-thirds of Russian oil imports within the next year, which could send oil prices headed for the top yet again. That’s great news for DVN and its investors.
Nonetheless, if you’re an income investor, chances are you’re not too concerned with price appreciation; you’re more interested in the quarterly dividend check. When you invest in Devon Energy, you can rest assured that meaningful dividend payments will come on schedule, just as they have for nearly 30 years.
Best for growth investors.
Dividend Yield: 0%.
Valuation Metrics: P/E ratio: ~30
Market Cap: ~$610 billion.
Meta Platforms, formerly Facebook, is a favorite on Wall Street; it’s the fourth most commonly found stock in ETF portfolios. However, the past year has been a tough time. Although that may send most investors running for the hills, it’s actually an opportunity.
Meta is a growth stock by just about any definition. The company has had solid revenue growth for years, and earnings per share (EPS) growth was impressive until the most recent earnings report. Moreover, the stock was known for tremendous price appreciation until the rug was pulled from the tech sector as inflation concerns set in earlier this year.
The declines have created an opportunity you don’t see often — a growth stock that can make value investors drool. Meta is trading with a P/E ratio of around 12, while the S&P 500’s P/E is over 19. The stock’s P/B ratio is also sitting at a five-year low.
Sure, there are a few short-term headwinds to consider, including:
Weak E-Commerce Spending. As prices rise and recession fears mount, e-commerce and consumer spending will likely fall, which could weigh on the company’s advertising revenue.
Transition to the Metaverse. Meta recently changed its name from Facebook in an effort to rebrand the company as the center of all things metaverse. This transition may come with some growing pains in the near future.
Economic Headwinds. Many experts are warning of a potential recession, which could eat into the company’s revenue and profitability in the short term.
Even with these headwinds, Meta offers a unique opportunity to tap into a stock that has historically outperformed the market in a big way but to do so at a steep discount to the current market value.
4. H&R Block Inc (NYSE: HRB)
Best for value investors.
Dividend Yield: ~3%.
Valuation Metrics: P/E ratio: ~11
Market Cap: ~$4.8 billion.
H&R Block is a household name, offering do-it-yourself tax services as well as full-service tax professionals. It’s also one of the most appealing value stocks on the market.
First, let’s address the elephant in the room — the 123 P/B ratio. Sure, that’s high by any standard. However, it’s inconsequential to HRB. The company has few tangible assets because it’s in the service sector.
To get a true picture of the discount the stock trades at, just look at its P/E and P/S ratios, which stand at around 5 and 1.4, respectively. That’s low for any sector. Its P/E ratio is about a quarter of that of the S&P 500.
Beyond the seriously discounted valuation, HRB stock has significant appeal in the current economic times.
All people eat, sleep, and pay taxes. Increasing interest rates and dwindling consumer spending may have a negative impact on other businesses, but people still have to file their taxes regardless of the state of the economy. HRB’s business model fares well even if a recession were to set in.
While other companies are looking for ways to cut costs headed into a recession, HRB is working on revamping its small-business product to increase profitability.
If that’s not enough for you, the company even provides a nice, thick layer of icing on the cake with a respectable 3% dividend yield.
5. ASML Holding NV (NASDAQ: ASML)
Best for banking on the microchip shortage
Dividend Yield: ~1.4%.
Valuation Metrics: P/E ratio: ~34
Market Cap: ~$ 263 billion.
There’s been quite a bit of interest in semiconductor manufacturers like NVIDIA (NASDAQ: NVDA) and Advanced Micro Devices (NASDAQ: AMD) as of late. A widespread semiconductor shortage is having a profound impact on nearly every industry from automobiles to computers and even healthcare.
However, companies like NVIDIA and AMD couldn’t survive without companies like ASML Holdings, a semiconductor equipment manufacturer that makes tools for the aforementioned brands and several others.
ASML Holdings enjoys a monopoly on the extreme ultraviolet (EUV) lithography machines needed to make the tiny patterns you find on microchips. They’re not just aesthetically pleasing either. The smaller and more complex these patterns, the more data a chip is capable of processing.
These machines aren’t cheap either. ASML snags about $150 million in revenue every time it sells one, and revenue is expected to climb ahead. Even with a potential recession looming, analysts are forecasting significant growth in earnings through the rest of 2022 and 2023.
The bottom line is simple. ASML holds a global monopoly on a tool used to create an in-demand product in a global supply shortage. Its tools are used to create the microchips auto manufacturers, medical device manufacturers, and tech companies can’t seem to get enough of. Not to mention, recent declines in the stock have brought the share price to a more than reasonable valuation.
6. Exxon Mobil Corp (NYSE: XOM)
Best for combating inflation.
Dividend Yield: ~3.6%.
Valuation Metrics: P/E ratio: ~7
Market Cap: $432 billion.
Exxon Mobil is one of the biggest names in oil and gas, making it a great stock to combat inflation. Economists often use the price of gasoline as a first-glance gauge of inflation. When gas prices start to rise, it begins a domino effect. Shipping costs increase, which leads to higher end-consumer prices.
That’s why Exxon Mobil is one of the best stocks you can buy to combat inflation.
The company is the largest gas station chain in the U.S. As prices rise, Exxon becomes a direct beneficiary that rakes in ever-growing revenues and profits. Sure, the stock isn’t so impressive when gas prices are down, but at the moment, it’s a great play.
Exxon isn’t just a gas station chain either. The company has its fingers in all streams of the production process, from drilling crude oil to refineries to selling the end product directly to consumers.
With gas prices rising to well over $4 per gallon, the company is adding plenty of free cash flow to its balance sheet.
At the same time, XOM shares are more than fairly priced. The company’s P/E ratio is well below the average for the S&P 500 and its P/S ratio is approaching 1. Add in a yield of around 4%, and we have a winner, my friends.
7. UGI Corp (NYSE: UGI)
Best for risk-averse investors.
Dividend Yield: ~1.5%
Market Cap: ~$6.1 billion.
Many investors’ stance on risk has changed since the bear market set in. If you’ve become more risk-averse and want a stable utility play with great dividends to fill the void in your portfolio, UGI is a compelling pick.
The company is a regulated natural gas and propane distributor with a history that spans well over a century. It has consistently paid dividends to investors for 138 years and raised its dividend payments for the past 35 years consecutively.
That means that even in 2001 when the dot-com bubble popped, in 2008 and 2009 when the Great Recession took hold, and in 2020 when COVID-19 reared its ugly head, UGI investors enjoyed dividend increases.
Sure, the stock price has had a painful fall over the past year, but its declines are still a meaningful beat compared to the S&P 500’s losses.
Moreover, the company’s growth metrics suggest recent declines will be short-lived. In the most recent quarter, UGI produced 34%+ revenue growth, 90%+ net income growth, 85%+ diluted earnings growth, and 42%+ net profit growth.
When you invest in UGI, you’re investing in a company that has more than a century under its belt — one that hasn’t missed a beat on paying investors dividends in all that time and has a history of outperforming the S&P 500 in bear markets.
8. Duke Energy Corp (NYSE: DUK)
Best for recession-proofing your portfolio.
Dividend Yield: ~4%.
Valuation Metrics: P/E ratio: ~20
Market Cap: ~$75 billion.
Duke Energy is one of the largest electric utility providers in the United States. The company serves more than 7.7 million energy customers and more than 1.6 million natural gas customers across six states.
There are three compelling reasons to consider investing in DUK in a bear market:
Consumer Habits. When the economy takes a hit, consumers spend less, but they just about always pay their utility bills. That makes DUK a great investment in a recession.
History. The company has historically outperformed the S&P in the face of multiple economic hardships.
Stability Over Growth. The company has seen some impressive growth in recent years but management’s core focus is on the stability of the business, making it a low volatility play.
Truth be told, there’s not much to say about Duke Energy. It’s not a sexy business, it doesn’t have a ton of growth prospects, and it’s not likely to make you rich any time soon. But what it’s not doing only serves to outline what it is doing.
Duke Energy is continuing its mission to provide its customers with quality, fairly priced services. As it does, it gives its investors stable returns, consistently paid dividends, and an easier time going to bed at night regardless of the state of the economy or broader market.
Final Word
The stocks above are some of the best to stand behind as the declines in the market continue. Considering the state of the market, every one of them is a large-cap stock, and most follow a more reserved investment strategy.
Though these are my favorite picks for investors looking for different options, you have your own unique risk tolerance and investment goals. Never blindly invest in stock picks you read about online, not even the picks above. Do your own research and make educated investment decisions based on what you learn and how it relates to your unique situation.
Disclosure: The author currently has no positions in any stock mentioned herein but may purchase shares of Devon Energy (DVN), H&R Block (HRB), ASML Holdings (ASML), UGI Corp (UGI), and Duke Energy (DUK) within the next 72 hours. The views expressed are those of the author of the article and not necessarily those of other members of the Money Crashers team or Money Crashers as a whole. This article was written by Joshua Rodriguez, who shared his honest opinion of the companies mentioned. However, this article should not be viewed as a solicitation to purchase shares in any security and should only be used for entertainment and informational purposes. Investors should consult a financial advisor or do their own due diligence before making any investment decision.
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Joshua Rodriguez has worked in the finance and investing industry for more than a decade. In 2012, he decided he was ready to break free from the 9 to 5 rat race. By 2013, he became his own boss and hasn’t looked back since. Today, Joshua enjoys sharing his experience and expertise with up and comers to help enrich the financial lives of the masses rather than fuel the ongoing economic divide. When he’s not writing, helping up and comers in the freelance industry, and making his own investments and wise financial decisions, Joshua enjoys spending time with his wife, son, daughter, and eight large breed dogs. See what Joshua is up to by following his Twitter or contact him through his website, CNA Finance.
A few weeks ago, I attended the Morningstar Investment Conference and took in the insights and predictions of all kinds of mutual fund managers and financial experts. On the whole, these folks weren’t too optimistic about earning exceptional returns on any kind of investment. Bonds and cash have paltry yields, and stocks aren’t as cheap as they were a couple of years ago. I think the collective investment advice of the event could be summed up by a line from Tom Hancock of money-management firm GMO, who said, “The only thing I like about stocks is they’re not bonds.”
During the opening session, Pimco co-chief investment officer and bond fund manager Bill Gross bemoaned the low rates on Treasuries. He also argued that investors shouldn’t expect 10% returns from stocks. But at the end of his talk, Gross suggested investors look for a solid, inflation-beating return from companies that pay steady dividends — companies such as Coca-Cola, Proctor & Gamble, Johnson & Johnson, Southern Company, and Duke Energy. (Full disclosure: I own shares of Johnson & Johnson, and when children pass me in the street they scream, “Gross!”)
Bill Gross was singing a tune similar to what has been wafting from the pages my Rule Your Retirement newsletter over the past few months: Stocks are not priced for exceptional returns over the next decade, and in a sideways market, dividends play an even bigger role in your portfolio.
As I listened to Gross, I wondered what would happen at the extreme: What if stocks didn’t gain a penny and all we received was dividends? I fired up Excel and found some fascinating figures.
Benefits of Stock Dividends
First off, let’s recap the benefits of stock dividends.
Unlike the interest from bonds, dividends tend to grow over time, historically at a rate that exceeds inflation. For most investors, the smart strategy is to use those dividends to buy more shares of stock, so that they’ll receive even more dividends, so they can buy even more stocks, and so on. In a previous post, I likened dividend-paying stocks to money-growing trees that produce a little more financial fruit each year. If you buy more trees with that cash crop, you reap even more fiscal flora. Given long enough time, you could have a whole greenhouse producing the green stuff.
To illustrate how this can pay off over the long term, let’s move from stalks to stocks and assume you own 1,000 shares of a stock that trades for $100, for a total investment of $100,000. (Note that this is just a hypothetical illustration; very, very few people should have so much money in one stock; also, the same principles apply to a mutual fund that pays dividends, even if you invest just $100.) The stock has a 3% dividend yield, so over the past year you received $3 per share, or a total of $3,000 in dividends.
Unfortunately, the price of this stock doesn’t move much over the next decade. In fact, it doesn’t move at all. Here’s what such an investment would look like after 10 and 20 years, if the dividend increases 6% a year but the stock price doesn’t budge.
Now
After 10 Years
After 20 Years
Value of Investment
$100,000
$151,726
$319,120
Number of Shares Owned
1,000
1,517
3,191
Dividends Received During the Last Year
$3,000
$7,885
$28,943
Annualized Return
N/A
4.3%
6.0%
While ten or twenty years of no price movement in a stock is disappointing, all is not lost. By reinvesting the dividends, you still earned money, thanks to owning more shares that each pay higher dividends.
Slowly Get Rich with Dividends
Like all illustrations of compound interest — i.e., earning interest on interest, or, in this case, dividends on dividends — it’s not something that will make you wealthy overnight — but it could help you get rich slowly. (Hey, that would be a great name for a website!). Also, like all illustrations of compounding growth, it looks better the more time you give it.
If you can stretch your investing horizon even further — or if you’re trying to convince a young investor to get started early — 30 years of reinvested dividends, growing 6% a year, will turn that $100,000 starting sum into $1.2 million, for an 8.6% annualized gain.
Earning 4% or even 8% on your long-term money may not sound exciting to some people. But that’s not tragic considering it’s based on a dire scenario: a stock that doesn’t increase in value for 10, 20, or 30 years. Of course, I hope that any stock or mutual fund you buy does increase in value. And when that happens, dividend reinvestment pays off even more, because you’re accumulating more shares to benefit from that capital appreciation.
An Uncertain Future with Stock Investments
This article isn’t intended to persuade you to buy stocks. Stocks are volatile and risky and often stinky and all that. I am not offering boilerplate legalese when I say that I’m not 100% confident stock investments will be worth more in 20 years than they are today.
At the Morningstar Investment Conference, BlackRock CEO Larry Fink said, “Anyone who plans to be around in 10 years should be in equities.” It’s not hard to see his point when you look at the alternatives. On the other hand, if you read the aforementioned link to Doug Short’s site, you won’t feel so sanguine about stocks.
As for me, I continue to own stocks in all forms — index funds, some actively managed funds, a handful of individual companies — but I don’t expect exceptional returns; I’m basing my retirement on my ability to save, not on the return I earn on the savings. And I expect that dividend reinvestment will be a large source of any returns I receive.
These reports, excerpted and edited by Barron’s, were issued recently by investment and research firms. The reports are a sampling of analysts’ thinking; they should not be considered the views or recommendations of Barron’s. Some of the reports’ issuers have provided, or hope to provide, investment-banking or other services to the companies being analyzed.
Salesforce
CRM-NYSE
Buy • Price $213.69 on June 12
by Goldman Sachs
We reiterate our Buy rating and $325 price target, as Salesforce’s AI Day provided color on the company’s generative-AI tech stack, market strategy, and monetization plans after a slew of product announcements over the past few months.
Salesforce’s approach is likely to set the industry standard going forward, given that: 1) it’s not reliant on any one foundation model, 2) it will gather relevant information from a variety of data sources to drive personalized and accurate prompts/outputs, and 3) it offers an enterprise-grade solution for data governance.
Combining AI, data, and Salesforce capabilities, the company is uniquely positioned to execute on this strategy.
Oracle
ORCL-NYSE
Buy • Price $116.43 on June 13
by Mizuho
Oracle reported strong fiscal fourth-quarter results ahead of consensus. We believe investors continue to underestimate Oracle’s potential over the medium term to generate solid top-line and cash-flow growth, and exceed its fiscal 2026 targets. Strong fiscal-fourth-quarter results with upside potential from solid AI momentum should improve investor sentiment and drive upside to fiscal-2026 estimates. We reiterate our Buy rating and raise our price target to $150 from $116.
Chevron
CVX-NYSE
Buy • Price $157.09 on June 14
by UBS
We recently hosted CFO Pierre Breber and General Manager, Investor Relations Jake Spiering for investor meetings. A key strength of Chevron is its balance sheet that’s at 4% net debt/capital with $15.7 billion of cash on hand. While only $5 billion of cash is needed to run operations, we see Chevron maintaining a higher balance in the current uncertain economic environment.
However, cash will be deployed over time, including to support shareholder returns, should Brent crude oil fall to $50 a barrel. Chevron stressed the importance of dividend growth, and we’re modeling in 6% annual growth through 2027, but we see upside at $75-plus Brent. We view the $7.6 billion PDCE Energy acquisition as positive, with the transaction accretive to free cash flow per share and the return of capital profile. There’s also minimal integration risk. Target price: $212.
Netflix
NFLX-Nasdaq
Buy • Price $423.97 on June 13
by Guggenheim
We continue to see underappreciated opportunity in Netflix shares over the next 12 months, even after year-to-date outperformance. We believe that the company’s position as the global leader in high-quality, long-form streaming video will drive further financial upside through higher subscription average revenue per user, advertising revenue, and margin expansion. Our review of Apptopia download data supports broader feedback that the recently expanded paid-sharing initiative is not driving a sustained increase in member churn.
We raise our price target to $500 from $375.
Kohl’s
KSS-NYSE
Outperform • Price $23.09 on June 14
by TD Cowen
We upgrade shares of Kohl’s to Outperform, as we expect new home-decor and gifting products, improved fashion execution, a simplified promotional strategy, and pragmatic store layout revisions to drive healthier and more consistent traffic and faster inventory turns. Valuation is attractive at five times enterprise value/Ebitda, with an 8% dividend yield.
We believe the new CEO, Tom Kingsbury, has practical retail ideas that are well positioned to work after many years of insufficient change. Our take is that Kingsbury has a practical merchant background and is leveraging this experience to drive positive change.
We also believe he is making pragmatic edits to the store, such as deleting unused registers, adding gifting tables in attractive parts of the store, and moving to a more modern markdown cadence.
We believe these plans are supported by an encouraging foundation for younger customers, given the new Sephora shop-in-shops, which are outperforming the rest of the business. Price target: $30.
Floor & Decor Holdings
FND-NYSE
Buy • Price $94.87 on June 15
by Jefferies
Checks indicate that Floor & Decor’s in-home pilot has ramped over the past few years, as Texas and Florida homeowners have found value in the convenience of a designer-led consultation in their residence. Access to customer homes is a rarity in retail. Floor & Decor’s in-home pilot launched in early 2020, and our checks indicate that it has expanded to 15% of the store base. Customers are tiered depending on project size and pay a fee of $199 (one-to-two rooms), $399 (more than two rooms), or $599 (more than 5,000 square feet) for in-home visits. Floor & Decor’s in-store conversion is already industry-leading at about 81%, with levels higher when design associates are involved. Theoretically, in-home experiences should drive conversion even higher.
Thinking longer term, we’re intrigued with the data that Floor & Decor’s design associates may be able to gather and potential for proactive outreach. Price target: $110.
To be considered for this section, material should be sent to [email protected].
Is it time to play defense? Economists have a fairly simple story to tell about the 2023 economy: things are weird. Inflation raged out of control in 2022, but has been falling in 2023. A volatile stock market remains below its 2021 highs, but still trended positive since the start of the year and may have entered a new bull market. Mortgage rates have tripled, but try telling that to the housing market. Economists and investors alike have issued steady warnings about a coming recession, but it feels like each month’s labor statistics beat the last.
A financial advisor can help you prepare your portfolio for a potential recession. Find a financial advisor today.
In other words, nobody really has a handle on what’s happening out there. That said, there are some potentially troubling signs ahead, especially for the third quarter of 2023. Several long-term factors may come to a head in late summer, ranging from top-level issues such as banking instability and delayed-impact Federal Reserve rate hikes to bottom-up issues such as resumed student loan payments. Together, it might all be enough to finally tip the economy into a long-awaited recession.
The right approach to this, as Morgan Stanley argued in a recent brief, might be to start thinking defensively.
“The stock market has managed to stay positive for much of this year. However with interest rates at their highest level in more than a decade and economic growth slowing, not to mention recent turmoil in the banking sector, uncertainty looms large,” writes Daniel Skelly, managing director and head of Morgan Stanley’s wealth management market research and strategy team.
“Additionally, equity valuations are already high relative to earnings – and current earnings estimates may be inflated. As a result, investors may see another drop in the stock market before they can truly declare the bear market over,” Skelly also writes.
In the face of this uncertainty, Skelly says investors may want to consider playing defense in the back half of 2023. In particular, he recommends seeking out dividend stocks. The reason is volatility, as dividend stocks tend to be an excellent buffer against unpredictable markets for four key reasons.
Price Supports
Dividend stocks tend to have built-in support against price volatility. In the short term, when companies issue a dividend to their shareholders, the price of a stock tends to drop. This has to do with a number of factors, most often the fact that new investors don’t want to invest if they’re being left out of the upcoming payments.
That’s not a bad thing, though, because when the share price drops for a dividend-paying stock the asset’s overall yield rises. For example, say you pay $10 per share for a stock that pays $1 in dividends. That’s a 10% yield on your investment ($1 dividend payment / the $10 you paid to receive it). If the share price drops to $8, but the company maintains its $1 per share dividend, that yield floats up to 12.5%.
That builds in a counter-cyclical pressure on the stock. As the share price falls, the yield increases. As the yield increases, more investors will get interested in the stock. That new interest will presumably drive new investment, boosting the share price back up. It’s not a guaranteed cycle, there’s much more going on here, but it can help smooth out volatility relative to stocks that generate their value entirely based on returns.
Stronger Returns
Historically, dividends have played a much larger role in market returns than many investors realize. As Morgan Stanley notes, in recent years dividend payments have lost ground compared to capital gains. From 2013 to 2022, only about 17% of the stock market’s overall returns came in the form of dividend payments. However, this has less to do with reduced payments and more to do with the explosive gains in stock value over that decade.
Historically, though, dividend payments have accounted for anywhere between 37% and 40% of the market’s overall returns.
Morgan Stanley expects a reversion to norms. “The next several years are likely to be marked by lower equity returns and higher volatility,” Skelly writes, “which could lead dividends to account for a greater portion of total stock market return.”
If the economy does slip into a recession, or even if the stock market simply enters longer-term bear territory, then capital gains-based returns will suffer. Long-term investors who can afford to wait out a downturn will probably be fine, but anyone who is looking to generate returns in the next year or two will probably face much less reliable, often less profitable, share prices. Dividend stocks can help offset that risk.
Signals for Good Fundamentals
Long-term investors should take note too, though.
As Morgan Stanley writes, dividends are a very strong bellwether for the underlying strength of a company. “When a company can reliably pay dividends or even increase them, it likely has a certain level of financial strength and discipline. For investors, this regular income stream can offer some hedge in what continues to be an uncertain stock market. In fact, in 2022, the S&P 500 overall lost about 18%, but the S&P 500 Value Index (which is often used as a proxy for dividend stocks) kept its losses to about 5%, and the S&P 500 High Dividend Index lost about 1%.”
In essence, when a company can afford to pay or maintain dividend payments, it’s signaling that it has significant cash on hand above and beyond its business needs. Now, to be sure, this is not always the case. It is not unheard of for corporate leadership to recklessly reward themselves and other investors at the expense of long-term business interests. So make sure you evaluate a company’s whole picture. If dividend payments take place in the context of weak leadership or an atmosphere of poor judgment, pay attention.
Otherwise, dividends can show that the company has strong revenue, good cash reserves and a handle on its debt, and that it expects this situation to continue. Especially if the economy enters recession, that’s an excellent signal for fundamental value. It suggests that this company can be a good long-term investment, regardless of current share prices.
Inflation Hedge
Finally, dividend stocks have historically been an excellent hedge against inflation.
Dividend-paying stocks tend to make up an enormous portion of the stock market’s return during periods of high inflation. One analysis by Fidelity found that when inflation was at 5% in the 1940s, 1970s and 1980s, dividends made up 54% of the S&P 500’s overall returns. This is in large part because companies can adjust their dividend payments on a quarterly basis, letting them keep up with the changing value of money.
In an atmosphere of ongoing inflation, dividend stocks are historically a strong choice.
Where to Focus Your Attention
For active stock pickers who would like to pursue a defensive dividend strategy, Morgan Stanley recommends four key areas of investment:
Industrials: Manufacturing and logistics firms are likely to benefit from increased infrastructure and defense spending, according to Morgan Stanley.
Health care: Medical firms have tended to outperform the market in past recessions, and are poised to take advantage of new technologies.
Consumer goods: Morgan Stanley expects these firms to raise consumer prices and recover well from high commodity prices over the past year.
Global stocks: Investing in global high-dividend stocks can allow investors to diversify their portfolios and capitalize on the momentum in this area.
When you look for dividend stocks, be somewhat judicious. In particular, be careful of stocks with yields that are too high, Skelly advises. This can signal an imbalance between the stock’s share price and its dividend payments, suggesting high payments that the underlying business may not be able to sustain.
Also, look at the stock’s price-to-earnings (P/E) ratio. Despite concerns over bear market territory, investors are also worried that many of the market’s high-performing stocks may be overvalued relative to the company’s underlying earnings. In those cases, investors can often expect the stock to lose value, and to lose value particularly quickly in the event of a recession.
Bottom Line
Many investors are worried about a recession in late 2023. To insulate your portfolio, Morgan Stanley recommends investing in dividend stocks to take advantage of their historic stability and potential for outsized returns in down markets. Active stock pickers who wish to pursue this strategy may consider dividend stocks in the industrial, health care and consumer goods sectors.
Dividend Investing Tips
If you need help investing in dividend stocks or want more guidance when it comes to your whole portfolio, consider speaking with a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Interested in dividend investing? You’ll want to familiarize yourself with how dividends are taxed. The exact dividend tax rate you pay varies by the type of dividends you have: non-qualified or qualified. Here’s everything you need to know about dividend taxes.
Eric Reed
Eric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
The dividend payout ratio is the ratio of total dividends paid to shareholders relative to the net income of the company. Investors can use the dividend payout formula to gauge what fraction of a company’s net income they could receive in the form of dividends.
While a company will want to retain some earnings to reinvest or pay down debt, the extra profit may be paid out to investors as dividends. As such, investors will want a way to calculate what they can expect if they’re a shareholder.
Understanding Dividends and How They Work
Before calculating potential dividends, investors will want to familiarize themselves with what dividends are, exactly.
A dividend is when a company periodically gives its shareholders a payment in cash, or additional shares of stock, or property. The size of that dividend payment depends on the company’s dividend yield and how many shares you own.
Many investors look to buy stock in companies that pay them as a way to generate regular income in addition to stock price appreciation. A dividend investing strategy is one way many investors look to make money from stocks and build wealth.
Investors can take their dividend payments in cash or reinvest them into their stock holdings. Not all companies pay dividends, and those that do tend to be large, established companies with predictable profits — blue chip stocks, for example. If an investor owns a stock or fund that pays dividends, they can expect a regular payment from that company — typically, each quarter. Some companies may pay dividends more frequently.
Pros and Cons of Investing in Dividend Stocks
Since dividend income can help augment investing returns, investing in dividend stocks — or, stocks that tend to pay higher than average dividends — is popular among some investors. But engaging in a strategy of purchasing dividend stocks has its pros and cons.
As for the advantages, the most obvious is that investors will receive dividend payments and see bigger potential returns from their holdings. Those dividends, in addition to stock appreciation, allow for two potential ways to generate returns. Another benefit is that investors can set up their dividends to automatically reinvest, meaning that they’re holdings grow with no extra effort.
Potential drawbacks, however, are that dividend stocks may generate a higher tax burden, depending on the specific stocks. You’ll need to look more closely at whether your dividends are “ordinary” or “qualified,” and dig a little deeper into qualified dividend tax rates to get a better idea of what you might end up owing.
Also, stocks that pay higher dividends often don’t see as much appreciation as some other growth stocks — but investors do reap the benefit of a steady, if small, payout.
What Is the Dividend Payout Ratio?
The dividend payout ratio expresses the percentage of income that a company pays to shareholders. Ratios vary widely by company. Some may pay out all of their net income, while others may hang on to a portion to reinvest in the company or pay off debt.
Generally speaking, a healthy range for payout ratios is from 35% to 55%. There are certain circumstances in which a lower ratio might make sense for a company. For example, a relatively young company that plans to expand might reinvest a larger portion of its profits into growth.
How to Calculate a Dividend Payout
Calculating your potential dividend payout is fairly simple: It requires that you know the dividend payout ratio formula, and simply plug in some numbers.
Dividend Payout Ratio Formula
The simplest dividend payout ratio formula divides the total annual dividends by net income, or earnings, from the same period. The equation looks like this:
Dividend payout ratio = Dividends paid / Net income
Again, figuring out the payout ratio is only a matter of doing some plug-and-play with the appropriate figures.
Dividend Payout Ratio Calculation Example
Here’s an example of how to calculate dividend payout using the dividend payout ratio.
If a company reported net income of $120 million and paid out a total of $50 million in dividends, the dividend payout ratio would be $50 million/$120 million, or about 42%. That means that the company retained about 58% of its profits.
Or, to plug those numbers into the formula, it would look like this:
~42% = 50,000,000 / 120,000,000
An alternative dividend payout ratio calculation uses dividends per share and earnings per share as variables:
Dividend payout ratio = Dividends per share / Earnings per share
A third formula uses retention ratio, which tells us how much of a company’s profits are being retained for reinvestment, rather than paid out in dividends.
Dividend payout ratio = 1 – Retention ratio
You can determine the retention ratio with the following formula:
Retention ratio = (Net income – Dividends paid) / Net income
You can find figures including total dividends paid and a company’s net income in a company’s financial statements, such as its earnings report or annual report.
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Why Does the Dividend Payout Ratio Matter?
Dividend stocks often play an important part in individuals’ investment strategies. As noted, dividends are one of the primary ways stock holdings earn money — investors also earn money on stocks by selling holdings that have appreciated in value.
Investors may choose to automatically reinvest the dividends they do earn, increasing the size of their holdings, and therefore, potentially earning even more dividends over time. This can often be done through a dividend reinvestment plan.
But it’s important to be able to know what the ratio results are telling you so that you can make wise decisions related to your investments.
Interpreting Dividend Payout Ratio Results
Learning how to calculate dividend payout and use the payout ratio is one thing. But what does it all mean? What is it telling you?
On a basic level, the dividend payout ratio can help investors gain insight into the health of dividend stocks. For instance, a higher ratio indicates that a company is paying out more of its profits in dividends, and this may be a sign that it is established, or not necessarily looking to expand in the near future. It may also indicate that a company isn’t investing enough in its own growth.
Lower ratios may mean a company is retaining a higher percentage of its earnings to expand its operations or fund research and development, for example. These stocks may still be a good bet, since these activities may help drive up share price or lead to large dividends in the future.
Dividend Sustainability
Paying attention to trends in dividend payout ratios can help you determine a dividend’s sustainability — or, the likelihood a company will continue to pay dividends of a certain size in the future. For example, a steadily rising dividend payout ratio could indicate that a company is on a stable path, while a sudden jump to a higher payout ratio might be harder for a company to sustain.
That’s knowledge that may be put to use when trying to manage your portfolio.
It’s also worth noting that there can be dividend payout ratios that are more than 100%. That means the company is paying out more money in dividends than it is earning — something no company can do for very long. While they may ride out a bad year, they may also have to lower their dividends, or suspend them entirely, if this trend continues.
Dividend Payout Ratio vs Dividend Yield
The dividend yield is the ratio of a stock’s dividend per share to the stock’s current price:
Dividend yield = Annual dividend per share/Current stock price
As an example, if a stock costs $100 and pays an annual dividend of $7 the dividend yield will be $7/$100, or 7%.
Like the dividend payout ratio, dividend yield is a metric investors can use when comparing stocks to understand the health of a company. For example, high dividend yields might be a result of a quickly dropping share price, which may indicate that a stock is in trouble. Dividend yield can also help investors understand whether a stock is valued well and whether it will meet the investor’s income needs or fit with their overall investing strategy.
Dividend Payout Ratio vs Retention Ratio
As discussed, the retention ratio tells investors how much of a company’s profits are being retained to be reinvested, rather than used to pay investors dividends. The formula looks like this:
Retention ratio = (Net income – Dividends paid) / Net income
If we use the same numbers from our initial example, the formula would look like this:
~58% = (120,000,000 – 50,000,000) / 120,000,000
This can be used much in the same way that the dividend payout ratio can, as it calculates the other side of the equation — how much a company is retaining, rather than paying out. In other words, if you can find one, you can easily find the other.
The Takeaway
The dividend payout ratio is a calculation that tells investors how much a company pays out in dividends to investors. Since dividend stocks can be an important component of an investment strategy, this can be useful information to investors who are trying to fine-tune their strategies, especially since different types of dividends have different tax implications.
In addition, the dividend payout ratio can help investors evaluate stocks that pay dividends, often providing clues about company health and long-term sustainability. It’s different from other ratios, like the retention ratio or the dividend yield.
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FAQ
How do you calculate your dividend payment?
To calculate your exact dividend payment, you’d need to know how many shares you own, a company’s net income, and the number of total outstanding shares. From there, you can calculate dividend per share, and multiply it by the number of shares you own.
Are dividends taxed?
Yes, dividends are taxed, as the IRS considers them a form of income. There may be some slight differences in how they’re taxed, but even if you reinvest your dividend income back into a company, you’ll still generate a tax liability by receiving dividend income.
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Hello! Dividend investing is a very interesting topic. Today, I have an expert who has appeared on Forbes, Motley Fool, MSN Money, TheStreet, and more, and he is going to share tons of great information on this subject. You may remember him from his previous contribution How I Became A Successful Dividend Growth Investor. This is a guest contribution by Ben Reynolds.Ben is the CEO of Sure Dividend.Sure Dividend helps people build high quality dividend growth portfolios for the long run.
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The size of your investment account now is based on your past decisions and for some people, being born into a wealthy family.It is what it is; you can’t change it.
How you invest will determine your investment returns and the yield on your investment portfolio when you are (early) retired.
I believe that dividend growth investing is uniquely situated to offer individual investors a way to build a portfolio for rising passive income that will lead to early retirement (depending of course on your income and expenses).
Related: What Are Dividends & How Do They Work? A Beginner’s Guide
What Is Dividend Growth Investing
Dividend growth investing is what it sounds like.The core idea of dividend growth investing is to invest in businesses via the stock market that are likely to pay growing dividends over time.
As an example, Johnson & Johnson’s (JNJ) dividend history over the last 20 years is shown below:
Source:Johnson & Johnson Investor Relations page Note:The 2017 number shows dividend payments to date.It will be higher than 2016 by the end of the year.
As you can see, Johnson & Johnson shareholders have seen their dividend income grow from $0.43 a share in 1997 to $3.15 a share in 2016.This is a 7.3x increase.More importantly, that 7.3x increase in income came without buying additional shares.
Dividend growth investing has a hidden benefit.It focuses you on the business, and not on the stock price.This means less (and hopefully no) panic selling during recessions.In fact, many dividend investors take advantage of market declines by purchasing into great dividend growth stocks while they are trading at a discount.
The reason dividend growth investing matches up with building an early retirement portfolio so well is because it provides rising income over time.This is a powerful feature that is not a characteristic of investing in bonds, gold, Bitcoin, or stocks that don’t pay dividends.
Reinvesting Dividends and Early Retirement
A portfolio that creates rising income over time is powerful.You can ‘super charge’ growth by reinvesting dividendsback into the portfolio.
When Johnson & Johnson pays its dividend, instead of taking it in cash, you can use that dividend to buy more shares of Johnson & Johnson.You can see how this can greatly increase your passive income stream in the future in the example below.
Johnson & Johnson currently has a dividend yield of 2.6%.The company has grown its dividend at 11% a year from 1997 through 2016.Forecasting 11% a year growth ahead may lead to disappointment; there’s no guarantee Johnson & Johnson will continue such strong growth.
Say the company grows its dividend at ‘just’ 7% a year going forward.If you are reinvesting dividends, your income stream from Johnson and Johnson will grow at 9.6% a year.Your income growth is simply the expected dividend per share growth rate plus the company’s current dividend yield (if dividends are reinvested).
With 9.6% a year compounding, your income from Johnson & Johnson will double about every 8 years.I don’t know many other situations outside of dividend growth investing where you have a high likelihood of doubling your income in under a decade.
Strong income growth over time is why dividend growth investing can help you achieve early retirement.It isn’t instantaneous, but it is achievable.
Where to Find Great Dividend Growth Stocks
Johnson & Johnson is a strong dividend growth stock…But it’s not the only one.There are other great businesses with long histories of increasing their dividend income every year.
My favorite place to find potential dividend growth stocks worthy of an early retirement portfolio is the Dividend Aristocrats Index.
The Dividend Aristocrats are a group of 51 stocks in the S&P 500 with 25+ consecutive years of dividend increases.A few examples of well-known Dividend Aristocrats are below:
Aflac (AFL)
3M (MMM)
Coca-Cola (KO)
Wal-Mart (WMT)
Exxon Mobil (XOM)
Procter & Gamble (PG)
Johnson & Johnson (JNJ)
The Dividend Aristocrats index is made up of businesses with long histories of rising dividends.A company simply cannot pay rising dividends for 25+ consecutive years without a strong and durable competitive advantage.
Why do competitive advantages matter? Warren Buffett himself says they are the key to investing.
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.” – Warren Buffett
Not surprisingly, the Dividend Aristocrats Index has outperformed the S&P 500 over the last decade by 2.8 percentage points a year…With lower volatility.
Source:S&P Fact Sheet
To put this into perspective, $1.00 invested in the Dividend Aristocrats index 10 years ago would be worth $2.59 now, versus $2.00 for the S&P 500 (both numbers include dividends).Moreover, your portfolio wouldn’t have had as severe price swings, because the Dividend Aristocrats index has lower volatility than the S&P 500.
Final Thoughts
There’s no question building a portfolio for early retirement can be complicated…But it doesn’t have to be.
By investing in individual great businesses and holding them for their rising income potential (dividend growth investing), you can build a portfolio that is very likely to pay you rising income over time.
And importantly, investing in individual stocks eliminates costly management fees from mutual funds and ETFs so your money is left to compound in your account, where it belongs.
The bottom line is that retirement requires a stream of income in excess of your expenses.That income stream must also grow at least as fast (though preferably much faster) than inflation.Otherwise, you lose purchasing power – and you won’t stay retired for long.
Dividend growth investing can create growing income streams that are likely to rise well in excess of inflation.The unique characteristics of dividend growth investing are a compelling match for those seeking early retirement.
Are you interested in dividend investing? Why or why not?
In Best Low-Risk Investments for 2023, I provided a comprehensive list of low-risk investments with predictable returns. But it’s precisely because those returns are low-risk that they also provide relatively low returns.
In this article, we’re going to look at high-yield investments, many of which involve a higher degree of risk but are also likely to provide higher returns.
True enough, low-risk investments are the right investment solution for anyone who’s looking to preserve capital and still earn some income.
But if you’re more interested in the income side of an investment, accepting a bit of risk can produce significantly higher returns. And at the same time, these investments will generally be less risky than growth stocks and other high-risk/high-reward investments.
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Determine How Much Risk You’re Willing to Take On
The risk we’re talking about with these high-yield investments is the potential for you to lose money. As is true when investing in any asset, you need to begin by determining how much you’re willing to risk in the pursuit of higher returns.
Chasing “high-yield returns” will make you broke if you don’t have clear financial goals you’re working towards.
I’m going to present a large number of high-yield investments, each with its own degree of risk. The purpose is to help you evaluate the risk/reward potential of these investments when selecting the ones that will be right for you.
If you’re looking for investments that are completely safe, you should favor one or more of the highly liquid, low-yield vehicles covered in Best Low-Risk Investments for 2023. In this article, we’re going to be going for something a little bit different. As such, please note that this is not in any way a blanket recommendation of any particular investment.
Best High-Yield Investments for 2023
Table of Contents
Below is my list of the 18 best high-yield investments for 2023. They’re not ranked or listed in order of importance. That’s because each is a unique investment class that you will need to carefully evaluate for suitability within your own portfolio.
Be sure that any investment you do choose will be likely to provide the return you expect at an acceptable risk level for your own personal risk tolerance.
1. Treasury Inflation-Protected Securities (TIPS)
Let’s start with this one, if only because it’s on just about every list of high-yield investments, especially in the current environment of rising inflation. It may not actually be the best high-yield investment, but it does have its virtues and shouldn’t be overlooked.
Basically, TIPS are securities issued by the U.S. Treasury that are designed to accommodate inflation. They do pay regular interest, though it’s typically lower than the rate paid on ordinary Treasury securities of similar terms. The bonds are available with a minimum investment of $100, in terms of five, 10, and 30 years. And since they’re fully backed by the U.S. government, you are assured of receiving the full principal value if you hold a security until maturity.
But the real benefit—and the primary advantage—of these securities is the inflation principal additions. Each year, the Treasury will add an amount to the bond principal that’s commensurate with changes in the Consumer Price Index (CPI).
Fortunately, while the principal will be added when the CPI rises (as it nearly always does), none will be deducted if the index goes negative.
You can purchase TIPS through the U.S. Treasury’s investment portal, Treasury Direct. You can also hold the securities as well as redeem them on the same platform. There are no commissions or fees when buying securities.
On the downside, TIPS are purely a play on inflation since the base rates are fairly low. And while the principal additions will keep you even with inflation, you should know that they are taxable in the year received.
Still, TIPS are an excellent low-risk, high-yield investment during times of rising inflation—like now.
2. I Bonds
If you’re looking for a true low-risk, high-yield investment, look no further than Series I bonds. With the current surge in inflation, these bonds have become incredibly popular, though they are limited.
I bonds are currently paying 6.89%. They can be purchased electronically in denominations as little as $25. However, you are limited to purchasing no more than $10,000 in I bonds per calendar year. Since they are issued by the U.S. Treasury, they’re fully protected by the U.S. government. You can purchase them through the Treasury Department’s investment portal, TreasuryDirect.gov.
“The cash in my savings account is on fire,” groans Scott Lieberman, Founder of Touchdown Money. “Inflation has my money in flames, each month incinerating more and more. To defend against this, I purchased an I bond. When I decide to get my money back, the I bond will have been protected against inflation by being worth more than what I bought it for. I highly recommend getting yourself a super safe Series I bond with money you can stash away for at least one year.”
You may not be able to put your entire bond portfolio into Series I bonds. But just a small investment, at nearly 10%, can increase the overall return on your bond allocation.
3. Corporate Bonds
The average rate of return on a bank savings account is 0.33%. The average rate on a money market account is 0.09%, and 0.25% on a 12-month CD.
Now, there are some banks paying higher rates, but generally only in the 1%-plus range.
If you want higher returns on your fixed income portfolio, and you’re willing to accept a moderate level of risk, you can invest in corporate bonds. Not only do they pay higher rates than banks, but you can lock in those higher rates for many years.
For example, the average current yield on a AAA-rated corporate bond is 4.55%. Now that’s the rate for AAA bonds, which are the highest-rated securities. You can get even higher rates on bonds with lower ratings, which we will cover in the next section.
Corporate bonds sell in face amounts of $1,000, though the price may be higher or lower depending on where interest rates are. If you choose to buy individual corporate bonds, expect to buy them in lots of ten. That means you’ll likely need to invest $10,000 in a single issue. Brokers will typically charge a small per-bond fee on purchase and sale.
An alternative may be to take advantage of corporate bond funds. That will give you an opportunity to invest in a portfolio of bonds for as little as the price of one share of an ETF. And because they are ETFs, they can usually be bought and sold commission free.
You can typically purchase corporate bonds and bond funds through popular stock brokers, like Zacks Trade, TD Ameritrade.
Corporate Bond Risk
Be aware that the value of corporate bonds, particularly those with maturities greater than 10 years, can fall if interest rates rise. Conversely, the value of the bonds can rise if interest rates fall.
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4. High-Yield Bonds
In the previous section we talked about how interest rates on corporate bonds vary based on each bond issue’s rating. A AAA bond, being the safest, has the lowest yield. But a riskier bond, such as one rated BBB, will provide a higher rate of return.
If you’re looking to earn higher interest than you can with investment-grade corporate bonds, you can get those returns with so-called high-yield bonds. Because they have a lower rating, they pay higher interest, sometimes much higher.
The average yield on high-yield bonds is 8.29%. But that’s just an average. The yield on a bond rated B will be higher than one rated BB.
You should also be aware that, in addition to potential market value declines due to rising interest rates, high-yield bonds are more likely to default than investment-grade bonds. That’s why they pay higher interest rates. (They used to call these bonds “junk bonds,” but that kind of description is a marketing disaster.) Because of those twin risks, junk bonds should occupy only a small corner of your fixed-income portfolio.
High Yield Bond Risk
In a rapidly rising interest rate environment, high-yield bonds are more likely to default.
High-yield bonds can be purchased under similar terms and in the same places where you can trade corporate bonds. There are also ETFs that specialize in high-yield bonds and will be a better choice for most investors, since they will include diversification across many different bond issues.
5. Municipal Bonds
Just as corporations and the U.S. Treasury issue bonds, so do state and local governments. These are referred to as municipal bonds. They work much like other bond types, particularly corporates. They can be purchased in similar denominations through online brokers.
The main advantage enjoyed by municipal bonds is their tax-exempt status for federal income tax purposes. And if you purchase a municipal bond issued by your home state, or a municipality within that state, the interest will also be tax-exempt for state income tax purposes.
That makes municipal bonds an excellent source of tax-exempt income in a nonretirement account. (Because retirement accounts are tax-sheltered, it makes little sense to include municipal bonds in those accounts.)
Municipal bond rates are currently hovering just above 3% for AAA-rated bonds. And while that’s an impressive return by itself, it masks an even higher yield.
Because of their tax-exempt status, the effective yield on municipal bonds will be higher than the note rate. For example, if your combined federal and state marginal income tax rates are 25%, the effective yield on a municipal bond paying 3% will be 4%. That gives an effective rate comparable with AAA-rated corporate bonds.
Municipal bonds, like other bonds, are subject to market value fluctuations due to interest rate changes. And while it’s rare, there have been occasional defaults on these bonds.
Like corporate bonds, municipal bonds carry ratings that affect the interest rates they pay. You can investigate bond ratings through sources like Standard & Poor’s, Moody’s, and Fitch.
Fund
Symbol
Type
Current Yield
5 Average Annual Return
Vanguard Inflation-Protected Securities Fund
VIPSX
TIPS
0.06%
3.02%
SPDR® Portfolio Interm Term Corp Bond ETF
SPIB
Corporate
4.38%
1.44%
iShares Interest Rate Hedged High Yield Bond ETF
HYGH
High-Yield
5.19%
2.02%
Invesco VRDO Tax-Free ETF (PVI)
PVI
Municipal
0.53%
0.56%
6. Longer Term Certificates of Deposit (CDs)
This is another investment that falls under the low risk/relatively high return classification. As interest rates have risen in recent months, rates have crept up on certificates of deposit. Unlike just one year ago, CDs now merit consideration.
But the key is to invest in certificates with longer terms.
“Another lower-risk option is to consider a Certificate of Deposit (CD),” advises Lance C. Steiner, CFP at Buckingham Advisors. “Banks, credit unions, and many other financial institutions offer CDs with maturities ranging from 6 months to 60 months. Currently, a 6-month CD may pay between 0.75% and 1.25% where a 24-month CD may pay between 2.20% and 3.00%. We suggest considering a short-term ladder since interest rates are expected to continue rising.” (Stated interest rates for the high-yield savings and CDs were obtained at bankrate.com.)
Most banks offer certificates of deposit with terms as long as five years. Those typically have the highest yields.
But the longer term does involve at least a moderate level of risk. If you invest in a CD for five years that’s currently paying 3%, the risk is that interest rates will continue rising. If they do, you’ll miss out on the higher returns available on newer certificates. But the risk is still low overall since the bank guarantees to repay 100% of your principle upon certificate maturity.
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7. Peer-to-Peer (P2P) Lending
Do you know how banks borrow from you—at 1% interest—then loan the same money to your neighbor at rates sometimes as high as 20%? It’s quite a racket, and a profitable one at that.
But do you also know that you have the same opportunity as a bank? It’s an investing process known as peer-to-peer lending, or P2P for short.
P2P lending essentially eliminates the bank. As an investor, you’ll provide the funds for borrowers on a P2P platform. Most of these loans will be in the form of personal loans for a variety of purposes. But some can also be business loans, medical loans, and for other more specific purposes.
As an investor/lender, you get to keep more of the interest rate return on those loans. You can invest easily through online P2P platforms.
One popular example is Prosper. They offer primarily personal loans in amounts ranging between $2,000 and $40,000. You can invest in small slivers of these loans, referred to as “notes.” Notes can be purchased for as little as $25.
That small denomination will make it possible to diversify your investment across many different loans. You can even choose the loans you will invest in based on borrower credit scores, income, loan terms, and purposes.
Prosper, which has managed $20 billion in P2P loans since 2005, claims a historical average return of 5.7%. That’s a high rate of return on what is essentially a fixed-income investment. But that’s because there exists the possibility of loss due to borrower default.
However, you can minimize the likelihood of default by carefully choosing borrower loan quality. That means focusing on borrowers with higher credit scores, incomes, and more conservative loan purposes (like debt consolidation).
8. Real Estate Investment Trusts (REITs)
REITs are an excellent way to participate in real estate investment, and the return it provides, without large amounts of capital or the need to manage properties. They’re publicly traded, closed-end investment funds that can be bought and sold on major stock exchanges. They invest primarily in commercial real estate, like office buildings, retail space, and large apartment complexes.
If you’re planning to invest in a REIT, you should be aware that there are three different types.
“Equity REITs purchase commercial, industrial, or residential real estate properties,” reports Robert R. Johnson, PhD, CFA, CAIA, Professor of Finance, Heider College of Business, Creighton University and co-author of several books, including The Tools and Techniques Of Investment Planning, Strategic Value Investing and Investment Banking for Dummies. “Income is derived primarily from the rental on the properties, as well as from the sale of properties that have increased in value. Mortgage REITs invest in property mortgages. The income is primarily from the interest they earn on the mortgage loans. Hybrid REITs invest both directly in property and in mortgages on properties.”
Johnson also cautions:
“Investors should understand that equity REITs are more like stocks and mortgage REITs are more like bonds. Hybrid REITs are like a mix of stocks and bonds.”
Mortgage REITs, in particular, are an excellent way to earn steady dividend income without being closely tied to the stock market.
Examples of specific REITs are listed in the table below (source: Kiplinger):
REIT
Equity or Mortgage
Property Type
Dividend Yield
12 Month Return
Rexford Industrial Realty
REXR
Industrial warehouse space
2.02%
2.21%
Sun Communities
SUI
Manufactured housing, RVs, resorts, marinas
2.19%
-14.71%
American Tower
AMT
Multi-tenant cell towers
2.13%
-9.00%
Prologis
PLD
Industrial real estate
2.49%
-0.77%
Camden Property Trust
CPT
Apartment complexes
2.77%
-7.74%
Alexandria Real Estate Equities
ARE
Research Properties
3.14%
-23.72%
Digital Realty Trust
DLR
Data centers
3.83%
-17.72%
9. Real Estate Crowdfunding
If you prefer direct investment in a property of your choice, rather than a portfolio, you can invest in real estate crowdfunding. You invest your money, but management of the property will be handled by professionals. With real estate crowdfunding, you can pick out individual properties, or invest in nonpublic REITs that invest in very specific portfolios.
One of the best examples of real estate crowdfunding is Fundrise. That’s because you can invest with as little as $500 or create a customized portfolio with no more than $1,000. Not only does Fundrise charge low fees, but they also have multiple investment options. You can start small in managed investments, and eventually trade up to investing in individual deals.
One thing to be aware of with real estate crowdfunding is that many require accredited investor status. That means being high income, high net worth, or both. If you are an accredited investor, you’ll have many more choices in the real estate crowdfunding space.
If you are not an accredited investor, that doesn’t mean you’ll be prevented from investing in this asset class. Part of the reason why Fundrise is so popular is that they don’t require accredited investor status. There are other real estate crowdfunding platforms that do the same.
Just be careful if you want to invest in real estate through real estate crowdfunding platforms. You will be expected to tie your money up for several years, and early redemption is often not possible. And like most investments, there is the possibility of losing some or all your investment principal.
Low minimum investment – $10
Diversified real estate portfolio
Portfolio Transparency
10. Physical Real Estate
We’ve talked about investing in real estate through REITs and real estate crowdfunding. But you can also invest directly in physical property, including residential property or even commercial.
Owning real estate outright means you have complete control over the investment. And since real estate is a large-dollar investment, the potential returns are also large.
For starters, average annual returns on real estate are impressive. They’re even comparable to stocks. Residential real estate has generated average returns of 10.6%, while commercial property has returned an average of 9.5%.
Next, real estate has the potential to generate income from two directions, from rental income and capital gains. But because of high property values in many markets around the country, it will be difficult to purchase real estate that will produce a positive cash flow, at least in the first few years.
Generally speaking, capital gains are where the richest returns come from. Property purchased today could double or even triple in 20 years, creating a huge windfall. And this will be a long-term capital gain, to get the benefit of a lower tax bite.
Finally, there’s the leverage factor. You can typically purchase an investment property with a 20% down payment. That means you can purchase a $500,000 property with $100,000 out-of-pocket.
By calculating your capital gains on your upfront investment, the returns are truly staggering. If the $500,000 property doubles to $1 million in 20 years, the $500,000 profit generated will produce a 500% gain on your $100,000 investment.
On the negative side, real estate is certainly a very long-term investment. It also comes with high transaction fees, often as high as 10% of the sale price. And not only will it require a large down payment up front, but also substantial investment of time managing the property.
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11. High Dividend Stocks
“The best high-yield investment is dividend stocks,” declares Harry Turner, Founder at The Sovereign Investor. “While there is no guaranteed return with stocks, over the long term stocks have outperformed other investments such as bonds and real estate. Among stocks, dividend-paying stocks have outperformed non-dividend paying stocks by more than 2 percentage points per year on average over the last century. In addition, dividend stocks tend to be less volatile than non-dividend paying stocks, meaning they are less likely to lose value in downturns.”
You can certainly invest in individual stocks that pay high dividends. But a less risky way to do it, and one that will avoid individual stock selection, is to invest through a fund.
One of the most popular is the ProShares S&P 500 Dividend Aristocrat ETF (NOBL). It has provided a return of 1.67% in the 12 months ending May 31, and an average of 12.33% per year since the fund began in October 2013. The fund currently has a 1.92% dividend yield.
The so-called Dividend Aristocrats are popular because they represent 60+ S&P 500 companies, with a history of increasing their dividends for at least the past 25 years.
“Dividend Stocks are an excellent way to earn some quality yield on your investments while simultaneously keeping inflation at bay,” advises Lyle Solomon, Principal Attorney at Oak View Law Group, one of the largest law firms in America. “Dividends are usually paid out by well-established and successful companies that no longer need to reinvest all of the profits back into the business.”
It gets better. “These companies and their stocks are safer to invest in owing to their stature, large customer base, and hold over the markets,” adds Solomon. “The best part about dividend stocks is that many of these companies increase dividends year on year.”
The table below shows some popular dividend-paying stocks. Each is a so-called “Dividend Aristocrat”, which means it’s part of the S&P 500 and has increased its dividend in each of at least the past 25 years.
Company
Symbol
Dividend
Dividend Yield
AbbVie
ABBV
$5.64
3.80%
Armcor PLC
AMCR
$0.48
3.81%
Chevron
CVX
$5.68
3.94%
ExxonMobil
XOM
$3.52
4.04%
IBM
IBM
$6.60
5.15%
Realty Income Corp
O
$2.97
4.16%
Walgreen Boots Alliance
WBA
$1.92
4.97%
12. Preferred Stocks
Preferred stocks are a very specific type of dividend stock. Just like common stock, preferred stock represents an interest in a publicly traded company. They’re often thought of as something of a hybrid between stocks and bonds because they contain elements of both.
Though common stocks can pay dividends, they don’t always. Preferred stocks on the other hand, always pay dividends. Those dividends can be either a fixed amount or based on a variable dividend formula. For example, a company can base the dividend payout on a recognized index, like the LIBOR (London Inter-Bank Offered Rate). The percentage of dividend payout will then change as the index rate does.
Preferred stocks have two major advantages over common stock. First, as “preferred” securities, they have a priority on dividend payments. A company is required to pay their preferred shareholders dividends ahead of common stockholders. Second, preferred stocks have higher dividend yields than common stocks in the same company.
You can purchase preferred stock through online brokers, some of which are listed under “Growth Stocks” below.
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Preferred Stock Caveats
The disadvantage of preferred stocks is that they don’t entitle the holder to vote in corporate elections. But some preferred stocks offer a conversion option. You can exchange your preferred shares for a specific number of common stock shares in the company. Since the conversion will likely be exercised when the price of the common shares takes a big jump, there’s the potential for large capital gains—in addition to the higher dividend.
Be aware that preferred stocks can also be callable. That means the company can authorize the repurchase of the stock at its discretion. Most will likely do that at a time when interest rates are falling, and they no longer want to pay a higher dividend on the preferred stock.
Preferred stock may also have a maturity date, which is typically 30–40 years after its original issuance. The company will typically redeem the shares at the original issue price, eliminating the possibility of capital gains.
Not all companies issue preferred stock. If you choose this investment, be sure it’s with a company that’s well-established and has strong financials. You should also pay close attention to the details of the issuance, including and especially any callability provisions, dividend formulas, and maturity dates.
13. Growth Stocks
This sector is likely the highest risk investment on this list. But it also may be the one with the highest yield, at least over the long term. That’s why we’re including it on this list.
Based on the S&P 500 index, stocks have returned an average of 10% per year for the past 50 years. But it is important to realize that’s only an average. The market may rise 40% one year, then fall 20% the next. To be successful with this investment, you must be committed for the long haul, up to and including several decades.
And because of the potential wide swings, growth stocks are not recommended for funds that will be needed within the next few years. In general, growth stocks work best for retirement plans. That’s where they’ll have the necessary decades to build and compound.
Since most of the return on growth stocks is from capital gains, you’ll get the benefit of lower long-term capital gains tax rates, at least with securities held in a taxable account. (The better news is capital gains on investments held in retirement accounts are tax-deferred until retirement.)
You can choose to invest in individual stocks, but that’s a fairly high-maintenance undertaking. A better way may be to simply invest in ETFs tied to popular indexes. For example, ETFs based on the S&P 500 are very popular among investors.
You can purchase growth stocks and growth stock ETFs commission free with brokers like M1 Finance, Zacks Trade, Wealthsimple.
14. Annuities
Annuities are something like creating your own private pension. It’s an investment contract you take with an insurance company, in which you invest a certain amount of money in exchange for a specific income stream. They can be an excellent source of high yields because the return is locked in by the contract.
Annuities come in many different varieties. Two major classifications are immediate and deferred annuities. As the name implies, immediate annuities begin paying an income stream shortly after the contract begins.
Deferred annuities work something like retirement plans. You may deposit a fixed amount of money with the insurance company upfront or make regular installments. In either case, income payments will begin at a specified point in the future.
With deferred annuities, the income earned within the plan is tax-deferred and paid upon withdrawal. But unlike retirement accounts, annuity contributions are not tax-deductible. Investment returns can either be fixed-rate or variable-rate, depending on the specific annuity setup.
While annuities are an excellent idea and concept, the wide variety of plans as well as the many insurance companies and agents offering them, make them a potential minefield. For example, many annuities are riddled with high fees and are subject to limited withdrawal options.
Because they contain so many moving parts, any annuity contracts you plan to enter into should be carefully reviewed. Pay close attention to all the details, including the small ones. It is, after all, a contract, and therefore legally binding. For that reason, you may want to have a potential annuity reviewed by an attorney before finalizing the deal.
15. Alternative Investments
Alternative investments cover a lot of territory. Examples include precious metals, commodities, private equity, art and collectibles, and digital assets. These fall more in the category of high risk/potential high reward, and you should proceed very carefully and with only the smallest slice of your portfolio.
To simplify the process of selecting alternative assets, you can invest through platforms such as Yieldstreet. With a single cash investment, you can invest in multiple alternatives.
“Investors can purchase real estate directly on Yieldstreet, through fractionalized investments in single deals,” offers Milind Mehere, Founder & Chief Executive Officer at Yieldstreet. “Investors can access private equity and private credit at high minimums by investing in a private market fund (think Blackstone or KKR, for instance). On Yieldstreet, they can have access to third-party funds at a fraction of the previously required minimums. Yieldstreet also offers venture capital (fractionalized) exposure directly. Buying a piece of blue-chip art can be expensive, and prohibitive for most investors, which is why Yieldstreet offers fractionalized assets to diversified art portfolios.”
Yieldstreet also provides access to digital asset investments, with the benefit of allocating to established professional funds, such as Pantera or Osprey Fund. The platform does not currently offer commodities but plans to do so in the future.
Access to wide array of alternative asset classes
Access to ultra-wealthy investments
Can invest for income or growth
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Alternative investments largely require thinking out-of-the-box. Some of the best investment opportunities are also the most unusual.
“The price of meat continues to rise, while agriculture remains a recession-proof investment as consumer demand for food is largely inelastic,” reports Chris Rawley, CEO of Harvest Returns, a platform for investing in private agriculture companies. “Consequently, investors are seeing solid returns from high-yield, grass-fed cattle notes.”
16. Interest Bearing Crypto Accounts
Though the primary appeal of investing in cryptocurrency has been the meteoric rises in price, now that the trend seems to be in reverse, the better play may be in interest-bearing crypto accounts. A select group of crypto exchanges pays high interest on your crypto balance.
One example is Gemini. Not only do they provide an opportunity to buy, sell, and store more than 100 cryptocurrencies—plus non-fungible tokens (NFTs)—but they are currently paying 8.05% APY on your crypto balance through Gemini Earn.
In another variation of being able to earn money on crypto, Crypto.com pays rewards of up to 14.5% on crypto held on the platform. That’s the maximum rate, as rewards vary by crypto. For example, rewards on Bitcoin and Ethereum are paid at 6%, while stablecoins can earn 8.5%.
It’s important to be aware that when investing in cryptocurrency, you will not enjoy the benefit of FDIC insurance. That means you can lose money on your investment. But that’s why crypto exchanges pay such high rates of return, whether it’s in the form of interest or rewards.
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17. Crypto Staking
Another way to play cryptocurrency is a process known as crypto staking. This is where the crypto exchange pays you a certain percentage as compensation or rewards for monitoring a specific cryptocurrency. This is not like crypto mining, which brings crypto into existence. Instead, you’ll participate in writing that particular blockchain and monitoring its security.
“Crypto staking is a concept wherein you can buy and lock a cryptocurrency in a protocol, and you will earn rewards for the amount and time you have locked the cryptocurrency,” reports Oak View Law Group’s Lyle Solomon.
“The big downside to staking crypto is the value of cryptocurrencies, in general, is extremely volatile, and the value of your staked crypto may reduce drastically,” Solomon continues, “However, you can stake stable currencies like USDC, which have their value pegged to the U.S. dollar, and would imply you earn staked rewards without a massive decrease in the value of your investment.”
Much like earning interest and rewards on crypto, staking takes place on crypto exchanges. Two exchanges that feature staking include Coinbase and Kraken. These are two of the largest crypto exchanges in the industry, and they provide a wide range of crypto opportunities, in addition to staking.
Invest in Startup Businesses and Companies
Have you ever heard the term “angel investor”? That’s a private investor, usually, a high net worth individual, who provides capital to small businesses, often startups. That capital is in the form of equity. The angel investor invests money in a small business, becomes a part owner of the company, and is entitled to a share of the company’s earnings.
In most cases, the angel investor acts as a silent partner. That means he or she receives dividend distributions on the equity invested but doesn’t actually get involved in the management of the company.
It’s a potentially lucrative investment opportunity because small businesses have a way of becoming big businesses. As they grow, both your equity and your income from the business also grow. And if the business ever goes public, you could be looking at a life-changing windfall!
Easy Ways to Invest in Startup Businesses
Mainvest is a simple, easy way to invest in small businesses. It’s an online investment platform where you can get access to returns as high as 25%, with an investment of just $100. Mainvest offers vetted businesses (the acceptance rate is just 5% of business that apply) for you to invest in.
It collects revenue, which will be paid to you quarterly. And because the minimum required investment is so small, you can invest in several small businesses at the same time. One of the big advantages with Mainvest is that you are not required to be an accredited investor.
Still another opportunity is through Fundrise Innovation Fund. I’ve already covered how Fundrise is an excellent real estate crowdfunding platform. But through their recently launched Innovaton Fund, you’ll have opportunity to invest in high-growth private technology companies. As a fund, you’ll invest in a portfolio of late-stage tech companies, as well as some public equities.
The purpose of the fund is to provide high growth, and the fund is currently offering shares with a net asset value of $10. These are long-term investments, so you should expect to remain invested for at least five years. But you may receive dividends in the meantime.
Like Mainvest, the Fundrise Innovation Fund does not require you to be an accredited investor.
Low minimum investment – $10
Diversified real estate portfolio
Portfolio Transparency
Final Thoughts on High Yield Investing
Notice that I’ve included a mix of investments based on a combination of risk and return. The greater the risk associated with the investment, the higher the stated or expected return will be.
It’s important when choosing any of these investments that you thoroughly assess the risk involved with each, and not focus primarily on return. These are not 100% safe investments, like short-term CDs, short-term Treasury securities, savings accounts, or bank money market accounts.
Because there is risk associated with each, most are not suitable as short-term investments. They make most sense for long-term investment accounts, particularly retirement accounts.
For example, growth stocks—and most stocks, for that matter—should generally be in a retirement account. While there will be years when you will suffer losses in your position, you’ll have enough years to offset those losses between now and retirement.
Also, if you don’t understand any of the above investments, it will be best to avoid making them. And for more complicated investments, like annuities, you should consult with a professional to evaluate the suitability and all the provisions it contains.
FAQ’s on High Yield Investment Options
What investment has the highest yield?
The investment with the highest yield will vary depending on a number of factors, including current market conditions and the amount of risk an investor is willing to take on. Generally speaking, investments with the potential for high yields also come with a higher level of risk, so it’s important for investors to carefully consider their options and choose investments that align with their financial goals and risk tolerance.
Some examples of high-yield investments include:
1. Stocks: Some stocks may offer high dividend yields, which is the annual dividend payment a company makes to its shareholders, expressed as a percentage of the stock’s current market price.
2. Real estate: Investing in real estate, either directly by purchasing property or indirectly through a real estate investment trust (REIT), can potentially generate high returns in the form of rental income and appreciation of the property value.
3. High-yield bonds: High-yield bonds, also known as junk bonds, are bonds that are issued by companies with lower credit ratings and thus offer higher yields to compensate for the added risk.
4. Private lending: Investing in private loans, such as through peer-to-peer lending platforms, can potentially offer high yields, but it also carries a higher level of risk.
5. Commodities: Investing in commodities, such as precious metals or oil, can potentially generate high returns if the prices of those commodities rise. However, the prices of commodities can also be volatile and subject to market fluctuations.
It’s important to note that these are just examples and not recommendations. As with any investment, it’s crucial to carefully research and consider all the potential risks and rewards before making a decision.
Where can I invest my money to get high returns?
There are a number of places you can invest your money to get high returns. One option is to invest in stocks, which typically offer higher returns than other investment options. Another option is to invest in bonds, which are considered a relatively safe investment option.
You could also invest in real estate, which has the potential to provide high returns if done correctly. Finally, you could also invest in commodities, such as gold or silver, which can be a risky investment but can also offer high returns.
What investments can I make a 10% return?
It’s difficult to predict exactly what investments will generate a 10% return, as investment returns can vary depending on a number of factors, including market conditions and the performance of the specific investment. Some investments, such as stocks and real estate, have the potential to generate returns in excess of 10%, but they also come with a higher level of risk. It’s important to remember that past performance is not necessarily indicative of future results, and that all investments carry some degree of risk
How to Make $500 a Month in Passive Income – SmartAsset
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You can produce $500 a month in passive income through savings accounts, certificates of deposit, stocks, bonds, funds and other investment vehicles. Each offers varying rates of return, degrees of safety, convenience, and liquidity. And each requires a significant initial investment to produce the required amount of passive income.
A financial advisor will be able to help with your investment decisions.
How to Make $500 a Month in Passive Income
Passive income generally refers to money you receive automatically without having to do anything such as work for wages. The most common way to generate passive income is through purchasing investments that pay you interest or dividends.
Producing passive income in this way calls for putting in money rather than putting in the effort. However, once you have invested the money, you can cash checks or receive deposits to your bank account without any intervention on your part.
And there are many investments you can make to produce $500 monthly in passive income. Here are some of the most accessible and reliable:
Savings Account
A bank or credit union savings account is as passive, safe and convenient as you can get. The top-paying savings accounts yield around 4.5% annually. At that rate, depositing approximately $133,333 will give you $500 monthly.
Certificates of Deposit
Certificates of deposit (CDs) are relatively safe, somewhat better-paying and a little less convenient than savings accounts. The best one-year bank certificates of deposit yield about 5% annually. So if you buy a $120,000 12-month CD, you’ll get about $500 in passive income each and every month.
Bonds
Corporate bonds are riskier than bank deposits. But AAA-rated bonds are generally considered safe and historically yield a little over 4%. If you buy $125,000 worth of AA-rated bonds, you can expect to receive the equivalent of $500 a month. That usually comes in quarterly, semi-annual or annual payments.
Dividend-paying Stocks
Shares of public companies that split profits with shareholders by paying cash dividends yield between 2% and 6% a year. With that in mind, putting $250,000 into low-yielding dividend stocks or $83,333 into high-yielding shares will get your $500 a month. Although, most dividends are paid quarterly, semi-annually or annually.
Diversified Securities Portfolio
A diversified securities portfolio of 60% stocks and 40% bonds has returned about 6.1% annually on average for the last decade, according to Vanguard. If future performance matches past performance, which is not guaranteed, $100,000 invested in a well-chosen 60/40 portfolio could grow by about $6,000 a year. The return includes dividends as well as price appreciation, so you may have to sell some of your investments to get $500 a month.
Exchange-Traded Funds
Low in cost and easy to buy, passively managed exchange-traded funds (ETFs) produce returns that vary according to whether they track stock, bond or other indexes. To cite one example, Vanguard’s High Dividend Yield ETF yields approximately 3%. You’d need to invest approximately $167,000 to get $500 a month in passive income from that ETF.
Real Estate
Purchasing shares of a Real Estate Investment Trust (REIT) is one popular way to get passive income from real estate. Publicly traded REITS pay dividends at an average rate of about 3%. So you’d need $167,000 to produce $500 in monthly passive income this way.
Other income opportunities that are somewhat less passive can also provide regular monthly income with varying amounts of effort. Drop shipping, for example, is a business model that involves setting up an online store and taking orders for products that pass directly to a supplier, who fulfills them without you having to do a thing except accept payment.
Direct investments in real estate, such as purchasing rental properties, can produce income that the internal revenue service (IRS) views as passive income, entitling it to more favorable tax treatment than earned income from working. However, managing residential real estate can involve considerable effort and attention on your part unless you pay a management company to take care of leasing, repairs and other tasks.
Bottom Line
To generate $500 a month in passive income you may need to invest between $83,333 and $250,000, depending on the asset and investment type you select. In addition to yield, you’ll want to consider safety, liquidity and convenience when selecting the investments you’ll employ to provide monthly passive income. However, once you’ve made the decision and put down your money, you can expect to receive regular payments without much, if any, additional future effort.
Tips for Investing
Financial advisors help investors analyze various investment options and can help create a plan of action to meet their goals. Before investing in any passive income investments, consider talking with an advisor to understand how it fits within your portfolio. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When investing your money, it is important to diversify your assets among many different types of stocks and bonds. This helps you gain exposure to multiple sectors of the market and benefit from their growth. Our asset allocation calculator helps you select a profile that’s right for you based on your answers to simple questions.
Mark Henricks
Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
There are people in the world who are best known for being famous for being famous.
Think Kim Kardashian and Paris Hilton.
Warren Buffett is not in this crowd (thank goodness!).
He is widely considered to be the most successful investor of all time. He is one of the very wealthiest people in the world – often THE wealthiest, depending on stock market valuations.
He has gotten to where he is by being a brilliant and insightful investor.
Like me, he wasn’t born into money, and he didn’t sign a fat contract for a book, a movie, a TV show or a record deal. (Note: I did sign a contract for my book deal, but I assure it wasn’t fat. Far from it. Haha…)
He did it the old fashioned way, which in today’s world seems almost radical.
In fact, there is nothing fancy or unusual at all about Warren Buffett – other than his phenomenal success.
That, and his overwhelming common sense, are the reason why so many people study his life and follow his lessons. And that’s why you should to.
Though he came from humble beginnings, Buffett is today the chairman, chief executive officer, and the largest shareholder of the multinational conglomerate holding company, Berkshire Hathaway.
His advice and pronouncements have become legendary, earning him the nickname “The Oracle of Omaha.”
What are some of the lessons that we can learn from this “oracle“?
1. Never Lose Money
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.“ – Warren Buffet
What makes it impossible to say that you are never going to lose money, is that it would mean that you would never take the calculated risks that are necessary to make money in the first place. But that’s the whole point – taking calculated risks.
Buffett doesn’t take wild chances. He has specific criteria in regard to any business that he will invest in, and this method keeps him from entering blind speculations.
If you use the never lose money mantra as a foundational strategy, it will have a positive effect on everything you will do, whether it has to do with a business or with investing. Many of the lessons that will follow will outline exactly how Buffett avoids losing money in the first place.
2. Buy Businesses – Not Stocks
“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.“ – Warren Buffet
Despite being perhaps the most successful investor in stock market history, Warren Buffett never actually bets on stocks, at least not the way that most investors and even fund managers do.
Buffett looks not at the performance of a given stock, but at the performance of the underlying business. This is critical, because a strong underlying business means that an investment will almost always payoff, at least sooner or later.
The reason why most investors fail to follow Buffett’s advice in this regard is because it requires a lot more work. You actually have to research the individual companies, and have a keen understanding of their business and how well they are faring against the competition. Market sentiment of the company’s stock has little to do with it.
3. Be in the Game For the Long Haul
“Someone is sitting in the shade today because someone planted a tree a long time ago.“ – Warren Buffet
When you look at the companies that Buffett either owns individually, or through Berkshire Hathaway, they’re all long-term investments. Buffett will buy stocks and hold onto them – not for years – but for decades. As long as the business is strong, the investment will payoff. Buffett’s track record, and the size of his portfolios, are testaments to the success of this strategy.
4. You Are Ultimately Responsible For Your Success or Failure
There are a lot more people in the financial markets then there is understanding of those markets. For this reason, people hold their investments through mutual funds, or pay for the services of investment advisers. Buffett holds that there is no substitute for getting involved in your investments.
Whether your investments succeed or fail will be completely on your shoulders, and not on those of your investment advisor. He maintains a policy of learning all about an investment and taking complete charge of how you go about managing it. In addition to being a solid strategy, this is also the only way that a novice investor learns to be an expert.
5. Keep Tight Control Over Your Living Expenses
If you look at the most successful people in almost any endeavor, you will typically see that they are people who live the life. That is, they live a lifestyle that is consistent with their level of success. This often leads to more than a little bit of lifestyle inflation, which helps explain how so many super successful people end up in a bankruptcy, and eventually, even the poor house.
Warren Buffett has done an outstanding job of keeping his ego in check when it comes to his lifestyle. It can even be said that he uses the same value principles for investments that he does in managing his own personal finances. For example, Buffett still lives in the same five-bedroom stucco house be purchased in Omaha Nebraska in 1957 for $31,500.
It’s certainly a nice enough house, but it doesn’t come close to the palaces that people who are nowhere near as wealthy as Buffett tend to live in. There is a strong message in that arrangement.
6. Invest in Quality
One of Buffett’s hallmark investment strategies is a investing in quality. This means that he invests in companies that have well-known, well-regarded products that add value to the consumer and the economy. The companies he inverts money in are usually household names, which is to say that they have both strong market penetration and brand recognition.
Many less successful investors are drawn to companies and industries that they know little or nothing about. They assume that the less they know, the more likely it is that the investment will be a success, as though it will succeed based on some unexplained mystery factor. Quality – not mystery – makes a company a long-term winning investment.
7. Buy Value
We can think of buying value as buying quality – when it goes on sale. This is part and parcel of Buffet’s never-lose-money strategy. Simply put, Buffett never pays full price for anything, including the investments that populate his portfolios.
He does this by buying companies that are selling at a discount to their real value. This strategy is more commonly referred to as value investing, which is the practice of buying stock in companies that are undervalued compared to other companies in their industry, as well as to the general market.
Buffet has this down to a science. He looks at the fundamentals of a company – it’s earnings, revenue, price-earnings ratio, return on equity and dividend yield, among other metrics – then he compares them to the same metrics in competing companies. If the company is generally strong compared to the competition, but the stock price is well below them, it becomes an investment candidate.
8. Avoid Fads
One thing that is immediately obvious about Buffett is that you’ll never see him running with the herd. That means no “Nifty Fifty” stocks, no hot stock of the year investments – and nothing that even hints at being trendy.
As an example, Buffett has publicly stated that he avoids buying stock in new social media, like Facebook and Google, citing the difficulty in determining their value and how they will fare in the future.
We can also bet that participating in fads would get in the way of investing in quality and value on a long-term basis. If it’s one thing Buffett is, it’s consistent.
9. Buy When “The Blood Is Running in the Streets”
“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.“ – Warren Buffet
I just said that you will never see Warren Buffett running with the herd, and this one of the best examples. His investment philosophy is simple – buy when everyone else is selling (be greedy), and sell when everyone else is buying (be fearful). This is consistent with the Wall Street saying (that few investors ever follow), the crowd is usually wrong.
This strategy is very consistent with Buffets strategy of buying value. If you buy when everyone else is selling, you will be able to get positions in strong companies for a lot less than you would pay when the market is running strong and everyone is buying.
10. Sell Your Losing Positions in Strong Markets
By the same token, if you wait to sell your losing positions until the market is particularly strong, you will minimize your losses. In some cases, you might even recover a profit.
Most investors have great difficulty mastering this concept. Once the stock starts rising, they tend to hold on to it under the assumption that will continue to do so. But in Buffets world, a losing position is a losing position, regardless of where the stock price is at.
11. Risk is Part of the Game – Get Used to It
“Risk comes from not knowing what you’re doing “ – Warren Buffet
Buffets way to wealth is actually a very risky one by conventional standards. He doesn’t invest heavily in safe assets like bonds and treasury bills. He invests primarily in stocks. But stocks are not nearly as risky as people tend think – as long as you know what you’re doing. And Buffet clearly does.
Buffet is able to eliminate most of the risk associated with stocks, by buying them cheaply enough that the speculation – and high prices – are completely squeezed out. Most of the positions that Buffet takes have nowhere to go but up. That is the result of buying after everyone else has sold out their positions.
In Buffets world, you would be buying heavily after a market crash, and keeping your powder dry when a bull market has been around for a few years.
12. Pay Close Attention to Management
“When a management with a reputation of brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.“ – Warren Buffet
While many investment analysts tend to focus on a company’s numbers, market position, specific assets, and even public sentiment, Buffett looks more closely at management. Every one of those tangible metrics can change in the future, substantially weakening a company. But the caliber of management represents the future of the business. With the right people at the helm, the business will grow and prosper no matter what challenges it may face.
13. Stick With What You Know
Just as Buffett avoids fads, he also tends to stick with what he knows when it comes to making investment decisions. In Buffett’s world, you have no business putting money into companies and industries that you know nothing about. Buffett’s billions came from the fact that he invested in businesses that he knew well.
The businesses that he does buy into also tend to be more basic in concept. As we saw in an earlier specific example, Buffett avoids buying into social media companies, since they are virtually new business concepts and not readily measurable. He favors easy to understand concepts like Coca-Cola and insurance.
14. Keep It Simple
“Derivatives are financial weapons of mass destruction. “ – Warren Buffet
There are a small number of investors on Wall Street who are making a lot of money in exotic investments, such as derivatives. Buffett avoids all such investment schemes, preferring to keep his investments basic. It once again gets back to the concept of investing in what it is that you know and understand.
15. Keep a Low Profile
Just as Warren Buffett lifestyle is incredibly simple considering his stature in the world, he also does his best to avoid the spotlight.
Sure, he’s a regular in giving an opinion on economic and public policy, but he avoids the outrageous behavior that has become symptomatic of the ultra-successful. But the success that he has is determined by the success of his business, rather than on his participation in out-of-the-box activities, or inflammatory public comments, designed mostly to draw attention.
We can probably guess that this low-profile existence makes it easier to focus on Buffett’s business at hand. After all, if you’re running around acting wild and making divisive comments, you won’t need to be spending a lot of time on rear-guard strategies to cover your tracks.
Even if you are not into investing, you can take all of these lessons from Warren Buffett’s life and apply them to your life and business, and with positive results.