Many people are looking for passive income, which is money people can earn without being actively involved. Investing in stocks that pay dividends is one of many ways to earn passive income. Dividends are payments shareholders receive from a company’s profits. Dividend stocks can create a stream of income for investors, or those payments can be reinvested to increase the likelihood of long-term growth.
The Basics of Dividends
Because they can pay shareholders income on a regular basis, dividend stock prices tend to be less volatile than others. A company’s board of directors determines whether a company pays dividends or reinvests profits into the company. They also determine how frequently dividend payments are made to shareholders.
Dividends can be paid to shareholders in the form of cash or stock depending on the company. That said, cash payments are a more common form of dividend payment. Why do companies pay dividends? As a ‘thank you’ to investors for putting their dollars into the organization. When shareholders buy shares in a company, it gives that organization more cash to use towards growing their business.
Dividends can be a powerful wealth-building tool, especially if investors hold stocks over extended periods. There is also the possibility of doing a dividend reinvestment plan or DRIP, which is when dividends are reinvested, using that income to purchase more stocks in the company. This strategy is a way to compound returns and fastrack growth.
Even if a company isn’t profitable in a quarter or year, they may still make payments to shareholders. For this reason, dividends can sometimes be a reliable form of income for investors. It’s important to buy dividend stocks from reliable companies with a strong track record when it comes to dividend payments.
How to Buy Dividend Stocks
Buying dividend stocks is the same process as buying any other stock. You can use a brokerage account to purchase or do so directly from the company if it offers that option. Once you’ve bought your dividend stocks, you wait for payments, which may happen monthly, quarterly, semi-annually, or annually depending on the company.
For those who aren’t sure how to check this information, consider reaching out to a finance professional to help decide which dividend stocks are best for your portfolio.
Before investing in dividend stocks, it’s critical investors research the companies they’re thinking about buying shares in. Some key characteristics to look out for are how established a company is and how reliable they are when it comes to dividend payments.
Certain industries have a proven record of consistent dividend payments, such as those in oil and gas, financial institutions, healthcare and utilities. The common denominator between these industries is that they deal with essential goods and services that tend to have steady demand.
Dividends and Taxes
Dividends are subject to taxes. There are two main types of dividends: qualified and non-qualified.
- Qualified dividends: These types of dividends have been held for a minimum holding period and usually come from domestic and sometimes foreign corporations. These dividends can result in a lower tax bill because they’re subject to the same tax rate as long-term capital gains. These rates are usually lower than ordinary income tax rates. Qualified dividend payments are reported on form 1099-DIV.
- Non-qualified dividends: These dividends are also known as ordinary dividends and get taxed as ordinary income. The majority of dividends and unqualified and thus, subject to a higher tax rate. For this reason, it is often recommended that investors hold nonqualified dividends in tax-advantaged accounts like an IRA.
For anyone unsure about how dividend payments may affect their tax liability, it may be helpful to reach out to a tax advisor or finance professional.
