Whether you start investing or have been investing for decades, dividends can be a valuable part of any investment portfolio. However, you tend to see dividends associated with people approaching retirement who are not looking to increase their investments that much, but rather to increase their income.
As with any other part of investing, you must first understand what you are investing in. While Reddit can provide a wealth of information on personal finance, we will focus on investing in anything that pays dividends.
Below is a guide to help you get started.
What are dividends?
Let’s first define what dividends are. Generally speaking, dividends are the distribution of a portion of a company’s profits paid to shareholders.
Dividends can provide income and growth for long-term investments. In addition, in many cases it will be possible to automatically reinvest the dividend back into the same company.
Example of dividends
Let’s use a basic example of how dividends can work. Company X’s share price is $ 100 and you own 100 shares. Company X announces that they will pay a dividend of $ 1.50 per share on the next payout date (companies declare the dividend a few weeks in advance).
You will receive $ 150 in dividends on the day of payment. After that, however, the share price is likely to fall by the same $ 1.50, since the company is technically worth a lot less after paying shareholders that amount per share.
Why companies pay dividends
So why would a company pay out some of its profits? The simple answer is to attract more investors.
Many dividend paying companies are solid and stable companies. By paying dividends, they attract investors by increasing demand for their shares.
Often times, the payment of dividends can be seen as a sign of power and strength within a company, making its stock more attractive to investors.
Another reason why dividends are attractive to investors is to generate passive income. Often, retirees seek to increase their income. As young investors, they don’t need a growth factor, so they turn to investments to pay dividends to make money during retirement.
Why companies don’t pay dividends
Many companies will not pay dividends for several reasons, the most important of which is that it hurts their bottom line. This is much less cash available to the company and therefore much less valuable in paying dividends. Typically, companies that are just starting out, like new online businesses, are more attentive to their cash flows.
First, less cash means less money to pay employees, renovate buildings, or grow your business in a myriad of other ways. Also, since the company’s value is less, the share price usually falls when the company pays dividends, which keeps smaller, lesser-known companies from doing so.
Others will argue that paying dividends does not attract retirees as many are investing in bonds instead due to dividend fluctuations.
On the other hand, bonds have a fixed yield, which may be more attractive since investors do not have to guess what income they might have, as is the case with dividends.
How to get dividends?
Earning dividends is easy. The company will automatically transfer money to your brokerage account at the time of distribution, buying a stock or mutual fund that pays dividends.
Another factor to consider is the dividend release date when the company declares dividends for that period.
The due date is usually later. The seller will receive dividends if you buy shares after the dividend payment date but before the payment date. As soon as the next payment date is due, you will receive your dividends.
Four companies paying dividends
As mentioned earlier, many dividend paying companies are long established companies. As a result, they will pay dividends to constantly attract investors, which further increases the value of their shares. Below are examples of four such companies.
Walmart
Walmart certainly doesn’t have the highest dividend payout, with a dividend yield of around 1.5% for one of the world’s largest companies. But again, one of the reasons people invest in Walmart is its staggering size, and dividends tend to be a bonus.
Another factor that many dividend investors will be looking at is the consistent increase in dividends. Walmart is currently in a 46-year growth streak, which gives investors something else to look forward to.
Exxon Mobil
Despite declining dependence on oil, Exxon Mobil remains one of the largest energy companies in the world. Another powerful company that can afford to reward loyal investors with a 6.7% dividend yield. Exxon also has a number of consecutive promotions: it is currently 37 years old and growing.
PepsiCo
Another company that has had to shake up their product line to stay strong is PepsiCo. Few of us buy soda, but PepsiCo owns the Aquafina snack line and even the Propel Water sports drink. Remaining as strong, Pepsi was able to pay out 2.9% dividend yield and steadily increase dividends over 48 years.
Procter & Gamble
Procter and Gamble is a retail giant with brands ranging from laundry detergents, paper towels and toilet paper to razors, soaps and shampoos.
The company will not go bankrupt anytime soon. Its strength makes them what many investors call “defensive stocks,” which means consumers will still buy groceries during a recession as they are more of a necessity than a luxury.
With a reasonable 2.5% dividend yield and a staggering 64-year streak of annual gains, it can also be considered a strong dividend stock.
When companies make payments
In most cases, companies pay dividends four times a year every quarter. However, companies can decide to pay dividends at different intervals if they wish. Two other less common options are monthly or annual dividends.
Tax incentives for dividends
Dividends can have tax benefits for both shareholders and the company paying them. The company, giving part of its profits to shareholders, will not be taxed on this money, so it will pay less taxes.
There may also be a tax break for shareholders. When a company pays dividends and the shareholder fulfills certain requirements, the dividends can be considered qualified dividends.
When the government finds the dividend acceptable, it will tax the lower rate. The exact tax rate varies depending on your tax category, but the tax on qualified dividends is always lower. Those in the lower tax bracket may not pay taxes at all on qualified dividends.
If you’re looking for more tax benefits when investing, check out the Top Ten Vanguard Index Funds.
Other important terminology
DRIP
As noted earlier, some companies and mutual funds allow shareholders to reinvest their dividends. This reinvestment is commonly known as DRIP (Dividend Reinvestment Plan).
Dividend Yield
Mathematically, you can calculate the dividend yield of a company by taking the amount of dividends paid per share, dividing it by the market price of the share per share, and then multiplying by 100, will you follow?
In layman’s terms, dividend yield is a measure of how much of its profits the company pays out in dividends. Thus, when evaluating dividend stocks, many investors will compare the company’s dividend yield to the industry average.
Ordinary dividends
Earlier we talked about qualified dividends and how they can provide tax benefits to investors. When dividends do not meet the requirements, they are known as regular dividends. These dividends are taxed at the same rate as your income.
Special dividends
From time to time, a company may find itself in a cash flow. When this happens, he can choose to pay a special dividend, a lump sum dividend payment that is usually higher than his regular dividend.
Dividend payout ratio
Many people will confuse dividend yield and dividend payout ratio as they have very similar calculations. Determining the payout ratio is how much of the company’s net profit they pay as dividends. Basically, the dividend payout ratio is used to determine the sustainability of a company’s dividend payout program.
A few words of warning
Dividends seem like a great way to invest, and they are, but they shouldn’t be your only way. There are many reasons to invest in dividend-paying stocks, but this should be done with caution.
Remember that even though income may qualify for lower taxation, sometimes it is not. Second, you will still be taxed on dividends, which may surprise you in the coming tax season.
Taxation can become especially painful if you reinvest your dividends. In this case, you will have no income in your bank account and, in fact, you will be charged a commission during taxation.
You should also be careful when using dividends as a source of income. As noted earlier, dividend payments can fluctuate from period to period. Companies may even vote to end payments altogether, with the result that you will not receive any income from these shares.
You won’t see the same growth in stocks that pay dividends over stocks that do not, so if you want to make a bigger profit, stocks that do not pay dividends may be the best option for you.
Four Tips for Investing in Dividends
Find reputable companies
When it comes to investing in dividends, look for companies with solid reputations, which means they are well established and have a high market value. Smaller companies usually don’t pay dividends. If you find one that has recently started, they may not be willing to pay anything substantial yet.
Find sustainable dividends
Remember the payout ratio mentioned earlier? Make sure you find a company with a payout ratio in the range of 30% to 50%, as anything higher can be volatile, and anything lower means that the company is more focused on growth than paying dividends.
Annual increments
For four dividend shares, it was previously noted that they all have a long streak of annual dividend increases. So, yes, you can find stocks with higher returns, but that means nothing if the company cannot maintain that return or increase its dividend from year to year. Investing is a long term game and dividend investing is no different.
Always reinvest dividends
When it comes to long-term investing, the best way to get the most out of your dividend investment over the long term is to participate in the DRIP program all the time.
Every time you reinvest your dividend, you buy a little more stock than before. So if you earn more in dividends, you can buy more stocks, can you see where this will lead? Always reinvest.
Final conclusions
Many people will think of dividends as easy passive income or retirement income, but that’s not all. Investing in dividend stocks will affect your taxes now and your income in the future.
The rule for any investor should be diversification, so dividend stocks should certainly have a stake in your portfolio, but don’t rely strictly on them. If you’re just chasing dividend yields, you may be missing the big picture or investing in a company that can’t sustain those yields.
As with any investment, gather as much information as you can before you get down to business.
This post was originally published on Wealth of Geeks.