Dividend stocks can be a great source of passive income. And while they can be risky, investors have to keep those risks in perspective.
Risk isn’t just about the possibility of share prices going down. Over the long term, there’s something else to focus on.
What is risk?
Warren Buffett – one of the best investors of all time – defines risk as the chance of permanent loss. That’s a good definition.
Share prices go up and down in ways that cash doesn’t. But that doesn’t necessarily make cash a safer investment.
Inflation is the rate at which money depreciates relative to other things. According to the latest data, it’s at 3.3%.
That means the value of cash is going down. And it doesn’t look like it’s coming back – it looks like a permanent loss.
The only way to avoid this is by finding something that can offer a better return. But that’s not easy with cash savings.
That means the risk – the probability of permanent loss – associated with cash savings is pretty high. But what about stocks?
Stocks and shares
I think several dividend stocks have a great chance of beating inflation over time. The key is to remember what they are.
Stocks and shares represent ownership stakes in businesses. So the question is whether those businesses can grow faster than inflation.
A lot of the time, there’s a very good chance they can. Supermarket Income REIT (LSE:SUPR) is one example.
The firm owns and leases a portfolio of retail properties. And it returns 90% of its taxable income to shareholders as dividends.
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Importantly, the firm’s contracts typically include inflation-linked increases. So the risk of being left behind is minimal.
How risky is the stock?
Shares in Supermarket Income REIT currently come with a 7.73% dividend yield. Add in inflation protection and it looks pretty attractive.
The share price will almost certainly go up and down. But what investors need to focus on is the underlying business.
Long leases and high-quality tenants mean income is relatively reliable. There are, however, some risks to consider.
The most obvious is that its tenant base is heavily concentrated. It relies on Tesco and Sainsbury for a lot of its income. This puts the company in a weaker position when it comes to renegotiating. And that’s the main risk for investors.
Despite this, I think the threat of permanent loss in real terms is much higher with cash. That’s why I think the stock is worth checking out.
Risks and rewards
Inflation means the chances of cash losing its value over time are pretty high. In ordinary savings accounts, I think it’s almost guaranteed.
With dividend stocks, the size of a potential loss is much higher. But the probability is much lower – at least, in some cases.
Investors need to weigh up which one is more important. And a lot depends on the context at hand. When it comes to things like paying your electricity bill or fixing your car, there’s no substitute for cash. It’s as simple as that.
For earning long-term passive income, however, I think it’s a different matter. In that situation, I think dividend stocks are the way to go.
