Dividend investing provides a great opportunity for investors who want to generate a steady income along with the market appreciation of their assets. This investment strategy can create profit and grow your wealth over time as long as you’re smart in purchasing stocks that pay dividends.
Investing in dividend stocks is also an excellent option for newbie investors who are looking for low-risk investments. However, like other investments, there are also drawbacks that you might encounter with dividend investing, especially if you don’t know what you’re doing.
That’s why you should know the nuts and bolts of this investment strategy. Here’s an article that will equip you with the necessary knowledge before you invest your money in dividend stocks.
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What Are Dividend Stocks?
Perhaps you might ask: why do people invest in dividend-paying stocks? Well, it’s because they’re safe and reliable investments.
Most companies, especially those at the top of the competition, pay dividends to stockholders as a form of profit-sharing. The law doesn’t really require corporations to pay dividends. Still, many companies issue a percentage of their earnings to their stockholders as a means to reward them for providing the capital and to attract more investors.
For investors, dividend investing is a smart way to create a stream of income or build long-term wealth through recurring dividend payments and capital appreciation. Depending on the policy of the company, dividends can be issued out quarterly, annually, or biannually.
Your shares of the company will be the basis for dividend payments. For instance, if you own a total of 100 shares of the XYZ Corporation that you purchased at $150 per share (an investment of $15,000), and it pays a cash dividend of $15 per share annually. Then, you get an annual yield of $1,500. That’s 10 percent of your total investment.
It’s up to you how you use this dividend payment. You can reinvest it in the same company, purchase stock in a different company, or pay for your rent. As long as the company is doing alright, you can get your dividend payments.
How Much is the Tax for Dividends?
Most dividend stocks qualify for lower tax rates. These qualified dividends are taxed at around 0 to 20 percent tax rate, depending on your tax bracket. Compared to ordinary income tax rates that go around 10 percent to 40 percent, dividends are taxed significantly lower.
On the other hand, there are also so-called “ordinary” dividends, which are taxed at a marginal tax rate. A great example of ordinary dividends are stocks that issue higher than average dividend payments.
Corporate structures may also create higher tax obligations for investors. Take, for instance, master limited partnerships and real estate investment funds. However, if you hold dividend stocks in a tax-advantaged individual retirement account, you won’t pay high taxes.
How to Invest in Dividend Stocks?
It’s crucial to know how you can start investing in dividend-paying stocks. Here are some steps to keep in mind for that purpose.
- Choose Quality Stocks. You can do no wrong if you invest your money in big corporations that are financially stable and with low volatility. Big-time players have sufficient capital to issue dividends, and they can manage fluctuations in the market very well.
- Look at the Stock’s Quote. Reading the stock’s quote is crucial to know the dividend amount a stock pays out. You can go to internet resources, such as NASDAQ.com, Yahoo Finance, and Google Finance, to read up free stock quotes for the companies you have in mind.
- Buy the Stock Directly or Through a Broker. There are two options for you when buying stocks. You can either purchase the stock directly through the corporation or a broker. You can look up Computer share’s database to know the companies that offer direct purchase programs. If you want to buy through a brokerage firm, you can find one online and open an account. Keep in mind the minimum investment for the direct purchase and the commission fees for the broker.
- Reinvest Your Dividend Yields. If you want to hold your asset for the long-term and grow your wealth, you can reinvest your dividends through a dividend reinvestment plan (DRIP). This plan is a convenient way to reinvest your yields into more stocks in the company. You can learn more about DRIP in this dividends for dummies guide.
- Keep Track of Your Investment. It’s the company’s call to lower, raise, or eliminate dividend payments to stockholders. That’s why it’s crucial to track your investment and be wise all the time. In case when dividends drop to a threshold or the company is deteriorating, it’s advisable to sell your stocks.
Investing in dividend stocks is an excellent way to create a stream of income and grow your wealth for the long-term. It’s also a safe and reliable investment. But there are also pitfalls that you have to prevent at all costs. Please make sure to read this guide if you want to be successful in this type of investment.