Pros And Cons of Dividend Stocks vs Index Funds
This article is for anyone deciding between dividend stocks vs index funds.
Because sometimes dividend investing can seem complex. But it doesn’t have to be.
So, let’s examine the pros and cons of dividends from these two alternatives. Then you can make the best decision for your investment dollars.
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
Choosing Between Dividend Stocks vs Index Funds
First, I have 5 good reasons to choose dividend stocks.
Second, we will consider 5 reasons why index investing might be the better choice.
Then, you can determine your personal best course of action and build your dividend portfolio however you choose.
5 Reasons To Choose Dividend Stocks Vs Index Funds
Choose dividend stocks vs index funds if you…
- Enjoy analyzing and selecting companies to invest in
- Desire more control over your dividend income strategy
- Won’t mind monitoring a portfolio of dividend stocks
- Prefer to save on investment fees
- Want to minimize taxable events
5 Reasons Not To Choose Dividend Stocks Vs Index Funds
Choose index funds rather than dividend stocks if you…
- Prefer a simple, set it and forget it investment strategy
- Desire a high level of diversification
- Have very small amounts to invest
- Can accept owning some of the less than best dividend stocks
- Are satisfied with matching market performance
The Case For Dividend Stocks
Next, let’s explore these 10 pros and cons in more detail.
Starting with the reasons for choosing an individual dividend stock approach…
1. Enjoy Analyzing And Selecting Companies To Invest In
First, you have to pick individual stocks. Furthermore, proper diversification calls for holding at least 20 stocks.
Therefore it takes time to find, analyze, and select the stocks to invest in. Thus, it’s important to have some stock selection skills. The time to do so. And enjoy going about the process.
Alternatively, you can get the aid of an investment service. For this, I like the Simply Investing Report.
Simply Investing covers hundreds of U.S. and Canada-based dividend stocks. And delivers its recommendations on the best ones to buy each month. Right to your inbox.
2. Desire More Control Over Your Dividend Income Strategy
By picking individual stocks. And creating a dividend portfolio. You more precisely control the dividend income metrics of each of your stock holdings.
Meaning each stock can be selected with the following factors in mind:
- Dividend yield
- Potential for dividend growth
- Dividend safety
- Industry representation
Thus, your portfolio can take on the exact traits and characteristics you desire.
3. Won’t Mind Monitoring A Portfolio Of Dividend Stocks
No matter how much money put towards dividend stocks. It is an essential practice to monitor the stocks owned. And the makeup of one’s dividend portfolio.
You must ask and address some important questions. At least once or twice per year.
First at an individual stock level.
Are the reasons I bought the stock still in place? If not, should I sell it?
Then, at an overall dividend portfolio level. Such as…
Has the makeup of my portfolio changed over time? Am I maintaining enough diversification? Am I remaining within my risk tolerance?
If not, what should I do about it? To ensure the portfolio meets my objectives.
4. Prefer To Save On Investment Fees
By building and managing a dividend stock portfolio. You won’t have to pay investment management fees.
Choose a free stock trading app like the one I use: Webull. Pick your stocks and manage your portfolio. By doing so, you invest at essentially zero cost.
Thus, keeping more of your hard-earned investment dollars. In your pocket, not someone else’s.
This is especially important for larger portfolios. Where even small fees can add up fast.
5. Want To Minimize Taxable Events
Unless holding dividend stocks in an individual retirement account (IRA, dividend investors pay two types of taxes.
First, on the dividend income received. Second, based upon share price gains when a stock is sold.
By choosing dividend stocks vs. index funds, dividend investors have complete control over if and when taxes are paid on share price gains. Also known as realized gains on shares sold.
This is done by buying and holding stocks indefinitely. Or, by using realized losses to offset realized gains on stock sales.
Okay. That completes our 5 reasons to choose dividend stocks vs index funds.
Now it’s time to flip the script on this argument…
The Case For Index Funds
Next, let’s examine why index funds are better than dividend stocks. Because the index fund approach will generally be superior if you…
1. Prefer A Simple, Set It And Forget It Investment Strategy
Rather than selecting and buying dozens of stocks. As an index fund investor, you can choose one or more dividend exchange-traded funds (ETF)s. Possessing the dividend investment objectives desired.
Buy it. Add to it as frequently as you wish. And for the most part, forget about it.
The fund will track the investment returns of the index it follows. There is little further work or monitoring required.
2. Desire A High Level Of Diversification
You can enjoy the peace of mind that comes with significant levels of diversification. Since it is common for index funds to hold hundreds of individual stocks.
And, you can obtain that diversification with your very first purchase. No matter how big or small.
3. Have Very Small Amounts To Invest
For those who can only spare a few dollars a month for investments. And if that’s the case, I would still encourage you to get started investing.
It just makes more sense to stick with an index fund vs dividend investing. Since there is little to be gained by owning fractional shares of 20-30 companies, in my opinion.
Later, as your portfolio grows. The time may come to consider individual stocks. The benefits, we have already discussed.
4. Can Accept Owning Some Of The Less than Best Dividend Stocks
On the other hand, one of the negatives of broad versification is this. Some stocks held by an index fund may not be the best investments.
Including investments, you would never consider making. If you were selecting each stock on an individual basis.
So, with index funds. You have to accept the best stocks. With some that may be subpar investments.
5. Are Satisfied With Matching Market Performance
Whatever index your fund seeks to track. Your investment return will closely match the return of that index.
There is little chance of outperforming the benchmark. Thus, when the index has high investment returns, so will you. And, vice versa.
Okay. That completes my top 5 reasons not to choose dividend stocks. And pursue an index fund strategy.
Next, allow me to touch on a couple of frequently asked questions. Then, I will wrap up.
Are Dividend Stocks Better Than Index Funds?
There are pros and cons to investing in individual dividend stocks vs getting dividends from index funds.
On one hand, investing in dividend stocks requires more time, expertise, and ongoing involvement. With the reward of pursuing a more focused dividend investing vs index funds strategy. And doing so at an extremely low cost.
On the other hand, index funds require little time to achieve high diversification. And market-matching returns. Through a low-cost set it and forget approach to investing.
Thus, dividend stocks are not better than index funds. They are simply a different means to pursue a dividend investing strategy. And for seeking to achieve one’s dividend investment goals.
Do You Have To Choose Between Dividend Stocks Vs Index Funds?
Finally, I think it is important to note that these two different approaches to dividend investing. Are not mutually exclusive.
Thus, you can choose to do both.
For example, I invest in both dividend stocks and index funds. First, I select and maintain a portfolio of individual dividend stocks made up of entirely U.S.-based companies.
Then, add an index fund comprised of international companies paying dividends. To achieve foreign diversification. Without having to select individual stocks from different countries.
This is just one example of a blended dividend investing strategy. Combining dividend stocks and an index fund. To achieve specific investment objectives.
Your approach might be different. Depending on how you choose to go about it.
Okay. That’s all for now.
Allow me to wrap up…
Final Thoughts: Choosing Between Dividend Stocks vs Index Funds
There are many good reasons to choose dividend stocks vs index funds. And vice versa.
It depends on how you want to go about executing your dividend income investing strategy.
Neither approach is better than the other. It mainly depends on your investing expertise and the amount of time you desire to commit to dividend investing.
More Reading About Dividend Stocks And Dividend Investing
- All of your dividend questions answered
- How to make $500 per month with stocks
- A popular dividend index fund from Vanguard
My Favorite Dividend Investing Resources
I mentioned several of my favorite dividend investing resources throughout the article. They are summarized here for your convenience.
- Trade stocks for free with the Webull app
- Get dividend stock recommendations from Simply Investing
- Manage all of your finances with Personal Capital
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.