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Income investing can be a very powerful method in the market which can help you generate a consistent monthly cash flow from the stock market, but many times people who invest in dividends make these large mistakes.
The first mistake that new income investors make is not checking the Fundamentals.
It can be very tempting to go find a list of dividend paying stocks and buy every stock on that list that have the best payouts. But sometimes that turns against you. Many companies will increase their dividends in order to get more investors for whatever reason; their goal is not always to benefit the stock holders.
Some of these companies will even increase the amount they pay out to help save the company from declaring bankruptcy by getting new people to invest money into it. This means that a lot of dividend stocks might actually just be poor companies trying to save themselves from going under.
It really isn’t going to do you much if you buy a stock that offers an 12% dividend and it goes bankrupt within the next 6 months. So be careful, many times high dividends can be a trap.
You can reduce this risk by taking a look at the individual company. Is it a company which is small and not really making money ? Or is it a company making money growing every day and has little or no debt.
Many times the growth in a large company can even be more profitable than the actual dividend. So checking out how strong the underlying company actually is can be well worth it.
The second mistake income investors tend to make is only relying on dividends. There are many different strategies out there to generate income on a stock.
In fact the most profitable method isn’t even dividends. Writing covered calls can be extremely profitable, especially if the stock is staying flat and you can sell them month after month.
What happens when you sell a covered call is that you are selling someone else the right to buy your stock from you at a certain price on or before a certain date. In other words they are paying you a premium to have the right to buy it from you.
Why would someone pay you a premium ? Well because if the stock makes a huge move it can potentially be worthwhile for them. So if they pay you $4 to buy the stock at $55 and it goes from $51 to 70 they can buy it from you at $55 and sell it at $70.
This does mean that by simply selling calls you are taking a risk that you do miss a big move in the position, but unless you believe the stock will make a large upward movement then it can be an extremely profitable situation.
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