Dividend investing is one of the best ways to grow your wealth and your portfolio over time.
Dividends are amazing for several reasons:
- The provide you with a solid income to own an asset
- The compound over time, increasing your yield
- Companies that pay dividends are usually pillars of their industry
I’m sure there are more, but let’s take a deeper look at investing for dividends.
What is a dividend and why is it important?
Dividends are profits paid to shareholders of a specific company. Many companies reward their shareholders through dividends. The board of directors of the company can choose to pay a certain amount per share and per period. Many companies pay dividends in standard time periods, such as quarterly or annually. For example, a company might pay a dividend of $1 per share per year. If you owned 500 shares, you would receive a check for $500 per year.
This is a great incentive to invest in companies that pay dividends. You basically get paid for owning a good business – what’s not to love? But this is only the beginning.
One of the many benefits of dividends is that you can usually choose to reinvest your dividends, which means you buy more shares of the company with the dividends. This, in turn, allows for larger dividends and the power of compounding. This should not be ignored. It has been calculated that dividends have accounted for 44% of total stock market returns over the past 80 years. This means that if you did not reinvest your dividends, you would suddenly see an 8% annual return reduced to a 5.5% annual return. It hurts in the long run!
Find Dividend-Paying Stocks
There are many ways to find dividend-paying stocks to invest in. best investment blogs focus on finding those stocks. The most common way to find these stocks is to search for stocks. I’ve already told you how to use an action screener, so if you’re not familiar, you can watch my video.
The second most common way is to invest in dividend-paying stocks through mutual funds and ETFs. A very popular ETF is the iShares Select Dividend ETF (NYSE: DVY). This fund holds the best dividend-paying stocks in the S&P 500, so it pays an excellent dividend itself.
As you work to build the perfect portfolio allocationlook to include a fund or ETF like DVY in your portfolio.
The problems of investing for dividends
However, it is important to remember that investing for dividends is not always straightforward and you just need to look for stocks that pay the highest dividends. There are times when dividends don’t matter, or they could paint a false picture of the company. Some unscrupulous companies pay extraordinarily high dividends before bad events just to give investors and owners a payday before the company goes bankrupt.
Like any investment, it is important that you do your homework and research on the company before investing – dividends or not!
Also, it is important to ask why this company pays a dividend. Usually this means the company has so much extra money they don’t know what to do with it – so they give it back to you, the owners. Sometimes that’s a good thing. Other times it could spell trouble for future growth (eg why aren’t they investing in the next “big thing”).
There is also tax implications on dividend investments depending on how you hold your dividend-paying stocks. If you invest in a retirement vehicle (like a 401k or IRA), or inside an HSA, you don’t have to worry about taxes when it comes to your dividends.
However, if you invest in a taxable account, you will pay tax on your dividends – even if you reinvest them! Remember that a reinvestment transaction is simply receiving the dividends and buying new shares. As such, make sure you are able to pay the taxes!
There are two tax treatments for dividends: ordinary and qualified. With ordinary dividends, you pay taxes on your dividend as ordinary income. Check your tax bracket to see what that tax rate might be.
Qualified dividends benefit from better tax treatment! According to the IRS, a dividend is qualified if you “have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.” So basically if you have held the stock for more than 6 months or so before the ex-dividend date.
If you have eligible dividends, your dividends are treated at the capital gains tax rate. There are three capital gains tax rates. Note that this varies depending on how you deposit. If you are a single filer, see this:
Personal income tax bracket
Eligible Dividend Tax Rates
If you are married and filing jointly, see this:
Eligible Dividend Tax Rates
Best places to invest in dividends
Depending on your strategy, there are a few places to invest in dividends that make a lot of sense. All of these options are on our list of Best Online Stock Brokers.
If you’re investing in dividends through low-cost mutual funds and ETFs, you should consider Avant-garde Or loyalty. They offer some of the best low-cost index funds and allow you to reinvest your dividends in these funds.
If you are considering owning individual stocks that pay dividends, we strongly recommend M1Finance. The reason is that M1 allows you to invest for free. If you want to own a basket of dividend-paying stocks, you set up your stock pie and M1 takes care of the rest. If you reinvest the dividends, the handle will also rebalance your pie.
Investing in dividends is a smart strategy for long-term wealth. However, make sure you understand what a dividend is, why it’s important, and how to best invest in it before you start.
Do you prefer to invest in stocks paying dividends?