Two Ways to Invest in Stocks: For Capital Appreciation, and for Dividends

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I received a reader inquiry that raises an interesting question about investment goals. I want to make one thing completely clear. I consider investing for capital appreciation and investing for dividends to be two very different goals. Therefore, I believe that they require different strategies and different techniques for accomplishing those strategies.

In a nutshell, investing for capital appreciation is "buy low, sell high." It is what I have been talking about in my posts about the market rally, the bear market that preceded the rally, the Timing Outlook, and so on. On the Sensible Stocks.com Web site, it is the main subject in the second column of the site map, the FAQ about stock investing, and many of the free articles. Investing for capital appreciation is mainly what my first book, Sensible Stock Investing, is about. The Capital Gains Portfolio tracked on my Web site is about investing for capital appreciation.

Investing for dividends, on the other hand, is about the accumulation of wealth by investing in stocks with healthy, reliable, and growing dividends. The dividends can be re-invested to accelerate the wealth accumulation process, or they can be taken out immediately and used as current income. Some resources on the Sensible Stocks.com Web site aimed at dividend investors are the third column of the site map, the FAQ about dividend investing, many of the free articles, and of course my e-book The Top 40 Dividend Stocks for 2009: Dividend Investing for the Long Haul. There is a Dividend Portfolio tracked on the Web site, and the tailor-made strategy governing that portfolio is discussed there too.

In my opinion, it is a good idea to be clear about what your goals are in investing in stocks. There is nothing wrong with having both goals--I do it myself, as reflected in the two portfolios. But I encourage you to segregate your portfolios for the two fundamental goals--capital appreciation and dividends--and to develop separate strategy or policy statements for each of them.

There are many commonalities across both goals, of course: Selecting excellent companies, buying them at advantageous values, and managing your portfolio well are best practices that apply to either strategy.

But there are important differences:

--The types of stocks one buys for capital appreciation or for dividends may have very different characteristics. For example, so-called "growth" stocks will predominate in a portfolio aimed at capital gains, while the dividend yield is a hugely important consideration in stocks for a dividend portfolio. (Dividend yield may be irrelevant in a "growth" stock.)

--The ways one controls risk after purchase will probably be different. In a capital gains strategy, stop-loss orders can be an important way to protect profits and curtail losing positions. In a dividend portfolio, on the other hand, stop-loss orders may not be used at all.

--It's always a good idea to "keep your eye on the ball." But the ball is different in the two strategies. In capital-gains investing, the ball is growth through price increases. In dividend investing, the ball is ever-increasing dividend streams. It probably would be going too far to say that the dividend investor stops caring about the prices of his or her stocks, but those prices truly take on less relevance. In fact, the dividend investor often welcomes price dips: It provides the opportunity to gather more shares for the same amount of money, which leads directly to more dividends based on the larger number of shares purchased.

I hope this has been clarifying. I know the distinction between investing for capital appreciation and investing for dividends can be confusing, especially since I deal with both on my Web site and in this Newsletter. If anybody has further questions, please e-mail them to me. Thanks to the reader who brought this to my attention.