If you invest in the stock market, you probably know you have to sell your shares to receive a payout. But what if you want to invest for income?
Some stocks offer an additional advantage when you buy shares, like dividend stocks, which regularly pay cash while you hold their shares. They give you the benefit of both worlds, investing in the stock market for long-term capital gains and a cash income.
So exactly what is a dividend stock? Read on to learn how to invest in dividend-paying stocks and more.
What are dividend stocks and how do they work?
Simply put, a dividend stock is a stock that pays dividends to its shareholders. A dividend is a portion of profits distributed to shareholders based on the number of shares they own. Dividends are paid in either cash or reinvestment in shares.
You can take cash dividends to supplement income, but if you want a long-term investment, you can create a plan for dividend reinvestment to purchase more shares.
Companies are not required to pay dividends and can change or cancel dividends at any time. The company's board of directors determines the dividend rates of a stock. Typically dividends are paid quarterly, although some stocks pay monthly dividends.
Dividends are a percentage of the shares you own. Let's say a company pays a 5% dividend, and the share price is $100. You would receive $5 in dividends per share from the company.
Why invest in dividends?
Dividends are a way to receive a consistent income from your investments. While you receive dividends from a stock, you can also grow your portfolio through the dividend stocks you invest in.
Dividend stocks are still subject to market volatility, but dividends are a potential way to increase investment income.
Typically stable companies pay dividends, given that they maintain a consistent cash flow and reward shareholders with part of their profits. In many cases, companies that pay dividends are considered strong and can weather any stock market volatility.
Additionally, dividend payments can help investors when the stock market is in a downtick. With low returns, dividend stocks can help supplement your earnings.
How to invest in dividend stocks
- First, find stocks that pay dividends. Your online broker will have a list of dividend-paying stocks.
- Evaluate the dividend stock to decide if it meets your investing strategy. Research the company and its history of paying dividends and performance in the stock market. Compare a company's dividend ratios to other similar companies. Compared to similar companies, an above-average ratio could be a good sign. If you're wondering how to invest in dividend monthly payment stocks, you can find how frequently a company pays dividends on the stock's quote.
- Diversify your portfolio. If you're buying individual dividend stocks, you can lower your risk of loss by investing in various companies.
- Purchase the stock. Either directly or through your brokerage firm.
There are different strategies for dividend investing; you can either focus on dividend growth or dividend yield. If you want to focus on high-yield dividends, consider looking for a company with consistent cash flow.
If you want a long-term investment, you can buy growth dividends from companies with potential (for example, energy stocks), ideally at a low stock price, and reap the benefits later.
If you're wondering how much you need to invest in dividend stocks, the answer is the same as most other stocks.
The share price and how many shares you want to buy will determine how much you spend on your investment, and therefore it varies depending on the individual stock.
What to consider when investing in dividend stocks:
- Payout ratio: A dividend payout ratio is the amount paid per share divided by the total number of shares. Ideally, a payout ratio should be sustainable, and anything above 60% is usually considered cause for concern.
- Past performance: High-yield dividend stocks ideally come from stable companies with a good track record of high revenue and growth. If a company's earnings are consistent and healthy, you are more likely to have consistent dividend payouts.
- History of raises: If a company can raise dividends over time, especially when the stock market is in a recession, it's considered a positive sign that the dividend stock is a good investment.
- High yield: A high-yield dividend stock is ideal for earning more for your investment, but you want to be sure a company can support the dividend yield over a long period.
- Dividend Aristocrats: The S&P 500 dividend aristocrats are dividend stocks that have increased dividends every year for the past 25 years, a $3 billion float-adjusted market cap, and have an average daily trading value of $5 million. Dividend aristocrats that make up the index are considered the best dividend stocks to invest in because of their consistency over many years.
What is the difference between investing in dividend stocks and dividend funds?
The dividend stocks in the ETF or mutual fund will pay the dividends to the funds, and the funds pay the dividends in a total payout directly to you.
You can invest in ETFs specialized in specific sectors; for example, you could invest in a renewable energy ETF, green energy ETF, or just an energy fund in general.
When considering how to invest in high yield dividend stocks, dividend ETFs or dividend mutual funds can help you efficiently diversify your portfolio rather than picking individual stocks yourself.
How are dividends taxed?
In most cases, the earnings on your dividend stocks are taxable. The main exception is if your dividend stocks are in a retirement account like an IRA. Any capital gains on a retirement account such as an IRA or Roth IRA are not taxed.
Another exception is if your income falls in the three lowest tax brackets. If you make less than $40,000 a year, you will not pay taxes on any dividends.
There are two types of dividends you can be taxed on: qualified or unqualified. A qualified dividend has a lower rate than a typical unqualified dividend. An unqualified dividend is taxable at your standard income rate.
A qualified dividend must be owned for 60 days in a 121-day period. This holding period prevents you from earning income with a tax advantage on a stock you only hold for a short period. The tax rate for qualified dividends is either 0%, 15%, or 20%, depending on your income tax bracket.
Some dividend stocks are excluded from being qualified dividends; for example, real estate investment trusts (REITs) are always taxed at your income rate.
The bottom line
High-dividend stocks are just one way investors can increase their income stream when putting their money in the stock market. You can invest in dividend stocks individually or as a fund with an ETF or mutual fund, and as an added bonus, some dividend stocks even have tax benefits.
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