Investing in dividend stocks is one option that is particularly appealing to investors interested in long-term, stable investments that promise a significantly greater return than bonds without a proportional increase in risk.
What is a dividend?
When you buy shares, you purchase a portion of the company. Shareholders who own more than a certain number of shares are entitled to dividends — a percentage of the company’s earnings paid at intervals throughout the year, most often quarterly.
The amount paid out in dividends is generally tied to the stock price, which fluctuates, and involves the company’s board deciding what portion of earnings to retain for operations and how much to pay shareholders.
Dividends can be issued in a number of forms, including additional shares, but cash payments are the most common.
As a company grows, dividend payments generally grow as well. Tracking the frequency of and changes in dividend payments from a company is a good way to get a sense of how well it’s doing and can help you decide whether you want to buy dividend stocks in that company.
Why should you consider dividend stocks?
First and foremost, investing in dividend stocks — provided the company is financially stable and growing — is a handy source of passive income.
Many of the larger established companies’ dividend payments grow with time, allowing for inflation and making a long-term investment an attractive option. Even if the amount of your dividend payout doesn’t increase, you can still count on a reliable stream of income.
If you do your research and find that a company’s dividend payments have steadily increased with no interruptions, you can assume the company is doing well.
For investors who are more interested in long-term gains, dividend stocks are also a good option. The success of your investment isn’t tied to shifting markets but to the success of the individual company. Fewer variables are in play, so you have less to be anxious about.
Dividends can also be given in shares. By choosing this option, you can build equity in a company and grow the return on your investment every year.
In a market downturn, dividend stocks are a significantly safer investment than anything else, which causes investors to move their money into this type of stock, shoring it up even further.
In some situations, income from dividend payments can be taxed at a lower rate — yet another reason to consider investing in dividend stocks, particularly if you are close to retirement. A dividend-paying investment can be a significant source of income once you stop working.
But consider the risks
It’s important to remember that a dividend stock will never be quite as safe an investment as a bond, and even in its limited way, it is still vulnerable to market changes.
As a rule, a higher dividend yield is better, but anything over 4 percent warrants careful scrutiny: It could imply a falling stock price or an unsustainable payout rate. The best thing to do in these situations is to compare financials between companies before investing.
For investors who are not experts, investing in individual dividend-paying stocks may not be wise. It’s much simpler to buy an exchange-traded fund or other mutual fund, which can provide you with a diversified portfolio.
The bottom line
Figuring out how to invest can certainly seem incredibly complicated, but once you’ve determined just what you’re hoping to get out of an investment, the process becomes significantly more straightforward. Happy investing!
