Investors who are looking for a steady stream of income often choose dividend stocks. While a dividend stock may appreciate in value it also provides quarterly cash payments which is an attractive feature for retirees. Because some companies offer high dividends to disguise problems in their operations it is important to consider this fact in order to achieve safe, better dividend investing. Companies that have not only paid dividends for years but have also steadily increased those dividends as their share price has increased are typically the best choices.
Dividend Investing Made Easy
Dividend investors are typically people who like to sleep well at night instead of tossing and turning as they worry about the safety of their investments. Thus, they choose solid companies with strong cash flow and a long history of paying dividends. And they use a dividend reinvestment plan in which their dividends are automatically reinvested every quarter. They still need to pay taxes on the dividends unless the stock is in a 401k plan or an IRA. In that case taxes are deferred until the money is withdrawn. These investors typically stop reinvesting at retirement in order to benefit from the steady stream of income provided by their dividends.
Investing for Dividends vs Capital Growth
Two arguments against investing in dividend stocks are these. Dividends are taxed when paid which causes a slight decrease in how fast an investment appreciates. And money that is paid out in dividends could have been used for research and development or in other ways to increase the value of the stock over the long term. The fact of the matter is that companies that make lots of money and pay healthy dividends are commonly companies that are growing and whose stocks are appreciating in value as well. In other words, they are both dividend and growth stocks.
Can Investment Losses Offset Dividend Income?
There is a high-dividend trap that investors need to be aware of. Companies whose business strategies are failing will often continue paying the same dividend even as their financial suffer and their share prices go down. Thus, they are paying a higher and higher rate of dividend. On the surface these stocks can look very attractive. But when the investor looks closer, they realize that they get trapped in these investments. While they are receiving the same dividend every quarter, they will take substantial losses if they choose to sell the stock because the company is failing.
Step by Step Dividend Investing
When investing in any stock it is important to understand what the company does to make money and how their business plan will continue to generate increasing returns over the years. The point of dividend investing is to have an investment that both appreciates in value and sends you a check every quarter. The first step in dividend investing is choosing companies that have strong cash flow and are likely to continue to have strong cash flow for years and years. The second step is to look for companies that have paid dividends for years, decades, or even more than a century and have steadily increased their payments over the years. A good third step is to choose companies that have dividend reinvestment plans if that is your preference.
Investing in Dividend Stocks for Passive Income
Younger investors generally invest for growth and those near or in retirement look for passive income such as interest from bonds or stock dividends. Two valid concerns for retirees is that inflation will increase the cost of living and low interest rates will not generate enough returns to live on. The value of investing in dividend stocks for passive income instead of buying bonds is that well-chosen dividend stocks commonly increase in value over the years. And these same stocks often keep increasing their dividends as well.
How Much Do You Need Invested to Live off Dividends?
To answer this question, you need to look at your lifestyle and how much you spend, any debts you have, etc. Then you need to look at how much your needs will increase or decrease over the years. Stocks in the S&P 500 generally pay between 2% and 5% a year in dividends. Now, in June of 2022, as stocks are falling in value, dividend rates will be going up for many. For a stock with a 5% dividend, you will need $100,000 in stock value to generate $5,000 in yearly dividends.
Dividend Investing Pros and Cons
There are two issues to consider when looking at dividend investing pros and cons. The first is the safety of your investment. If you have opted for a stock that pays extraordinarily high dividends you will get a healthy check every quarter but your investment might not be safe over the long term. For solid companies with good financials the issues are Two, Paying taxes on dividends and then having to reinvest can be an irritant. And maybe the company would do better by using dividend money to grow the business.