Many beginning investors do not understand what a dividend is— as it relates to an investment—particularly for an individual stock or mutual fund. A dividend is a payout of aportion of a company's profit to eligible stockholders,typically issuedby a publicly traded company.
However, not all companies pay a dividend. Usually, the board of directors determines if a dividend is desirable for their particular company based on various financial and economic factors. Dividends are commonly paid in the form of cash distributions to the shareholders on a monthly, quarterly or yearly basis.
Key Takeaways
- Dividends are a discretionary distribution of profits which a company's board of directors gives its current shareholders.
- A dividend is typically a cash payout to investors made at least once a year, but sometimes quarterly.
- Stocks and mutual funds that distribute dividends are likely on sound financial ground, but not always.
- Investors should be aware of extremely high yields, since there is an inverse relationship between stock price and dividend yield and the distribution might not be sustainable.
- Stocks that pay dividends typically provide stability to a portfolio, but do not usually outperform high-quality growth stocks.
Dividend Basics
Shareholders of any given stock must meet certain requirements before receiving a dividend payout, or distribution. You must be a "shareholder of record" on or subsequent to a particular date designated by the company's board of directors in order to qualify for the dividend payout. Stocks are sometimes referred to as trading "ex-dividend,"which simply means that they are trading on that particular day without dividend eligibility. If you buy and sell stock on its ex-dividend date, you will not receive the most current dividend payout.
Now that you have a basic definition of what a dividend is and how it is distributed, let's focus in more detail on what more you need to understand before making an investment decision.
What Is the Dividend Yield?
It may be counter-intuitive, but as a stock's price increases, its dividend yield actually decreases. Dividend yield is a ratio of how muchcash flowyou are getting for each dollar invested in a stock.Many novice investors may incorrectly assume that a higher stock price correlates to a higher dividend yield. Let's delve into how dividend yield is calculated, so we can grasp this inverse relationship.
Dividends are normally paid on a per-share basis. If you own 100 shares of the ABC Corporation, the 100 shares is your basis for dividend distribution. Assume for the moment that ABC Corporation was purchased at $100 per share, which implies a total investment of $10,000. Profits at the ABC Corporation were unusually high, so the board of directors agrees to pay its shareholders $10 per share annually in the form of a cash dividend. So, as an owner of ABC Corporation for a year, your continued investment in ABC Corp result in $1,000dollars of dividends. The annual yield is the total dividend amount ($1,000) divided by the cost of the stock ($10,000) which equals 10%.
If ABC Corporation was purchased at $200 per share instead, the yield would drop to 5%, since 100 shares now costs $20,000 (or your original $10,000 only gets you 50 shares, instead of 100). As illustrated above, if the price of the stock moves higher, then dividend yield drops and vice versa.
Dividends are a piece of a company's profits paid out to eligible stockholders on a monthly, quarterly or yearly basis. Generally, a company's ability to pay dividends is a sign of good corporate health.
Assessing Dividend-Paying Stocks
The real question one has to ask is whether dividend-paying stocks make a good overall investment. Dividends are derived from a company's profits, so it is fair to assume that in most cases, dividends are generally a sign of financial health. From an investment strategy perspective, buying established companies with a history of good dividends adds stability to a portfolio. Your $10,000 investment in ABC Corporation, if held for one year, will be worth $11,000, assuming the stock price after one year is unchanged. Moreover, if ABC Corporation is trading at $90 share a year after you purchased for $100 a share, your total investment after receiving dividends is still break even ($9,000 stock value + $1,000 in dividends).
This is the appeal ofbuying stocks with dividends—it helps cushion declines in the actual stock prices, but also presents an opportunity for stock price appreciation coupled with a steady stream of income from dividends. This is why many investing legends such as John Bogle and Benjamin Grahamadvocatebuying stocks that paydividends as a critical part of the total "investment" return of an asset.
The Risks to Dividends
During the financial meltdown in 2008-2009, almost all of the major banks either slashed or eliminated their dividend payouts. These companies were known for consistent, stable dividend payouts each quarter for literally hundreds of years. Despite their storied histories, many dividends werecut.
In other words, dividends are not guaranteed and are subject to macroeconomic as well as company-specific risks. Another potential downside to investing in dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders. There are someexceptions, but high-growth companies usually do not pay sizable amounts of dividends to their shareholders even if they have significantly outperformed the vast majority of stocks over time. Growth companies tend to spend more dollars on research and development, capital expansion, retaining talented employees, and mergers and acquisitions. For these companies, all earnings are considered retained earnings and are reinvested back into the company instead of issuing a dividend to shareholders.
It is equally important to beware of companies with extraordinarily high yields. As we have learned, if a company's stock price continues to decline, its yield goes up. Many rookie investors get teased into purchasing a stock just on the basis of a potentially juicy dividend. There is no specific rule of thumb in relation to how much is too much in terms of a dividend payout.
Special Considerations
The average dividend yield onS&P 500 indexcompanies that pay a dividend historically fluctuates somewhere between 2%and 5%, depending on market conditions. In general, it pays to do your homework on stocks yielding more than 8% to find out what is truly going on with the company. Doing this due diligence will help you decipher those companies that are truly in financial shambles from those that are temporarily out of favor, and therefore present a good investment value proposition.
FAQs
Overall, dividend investing can be a great way for investors to generate income, achieve long-term growth, and reduce portfolio risk.
Are dividend stocks the best choice for a passive income investing strategy? ›
Overall, investing in dividend stocks can provide a reliable source of passive income, making them an attractive investment option for those seeking financial stability and long-term growth.
How much to invest to get $1,000 a month in dividends? ›
Reinvest Your Payments
The truth is that most investors won't have the money to generate $1,000 per month in dividends; not at first, anyway. Even if you find a market-beating series of investments that average 3% annual yield, you would still need $400,000 in up-front capital to hit your targets.
Is dividend investing better than growth? ›
You may find dividend stocks suitable if you seek stocks with lesser risk, steady returns, and immediate benefits. In contrast, growth stocks may be suitable if you want greater returns over the years and can stomach the volatility and risk coming along.
Why is dividend investing good? ›
Dividends are a major factor in reducing overall portfolio risk and volatility. In terms of reducing risk, dividend payments mitigate losses that occur from a decline in stock price. But the risk reduction benefit of dividends goes beyond that basic fact.
What are the pros and cons of dividend investing? ›
The Pros & Cons Of Dividend Stock Investing
- Pro #1: Insulation From The Stock Market. ...
- Pro #2: Varied Fluctuation. ...
- Pro #3: Dividends Can Provide A Reliable Income Stream. ...
- Con #1: Less Potential For Massive Gains. ...
- Con #2: Disconnect Between Dividends & Business Growth. ...
- Con #3: High Yield Dividend Traps. ...
- Further Reading.
The Risks to Dividends
In other words, dividends are not guaranteed and are subject to macroeconomic as well as company-specific risks. Another potential downside to investing in dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders.
Are dividend stocks a good retirement strategy? ›
As a reliable source of income that may be used to complement Social Security and other retirement benefits, dividend growth stocks can be a vital component of a retirement strategy. Retirement investors can keep their purchasing power and be protected from inflation thanks to the steady dividends growth.
Is dividend investing safer than growth? ›
Some of the advantages of dividend stocks are that they tend to outperform growth stocks, offer consistent cash flow at regular intervals, and because stocks that offer dividends typically indicate that a company is financially healthy enough to pay shareholders cash, the investment can be less risky.
How do I make $500 a month in dividends? ›
Dividend-paying Stocks
Shares of public companies that split profits with shareholders by paying cash dividends yield between 2% and 6% a year. With that in mind, putting $250,000 into low-yielding dividend stocks or $83,333 into high-yielding shares will get your $500 a month.
The S&P 500 offers a current dividend yield of 1.6% and has delivered an average of 2.34%. That means if you want to generate $100,000 in annual passive income from a vanilla index fund, you would need $4,273,504 in assets ($100,000 divided by 2.34%).
What is the highest dividend paying stock? ›
Comparison Results
| Name | Price | Price Change |
|---|
| MO Altria Group | $45.53 | $0.31 (0.69%) After 0.02% |
| T AT&T | $15.93 | $0.02 (-0.13%) After 0% |
| XRX Xerox | $15.24 | $0.15 (0.99%) After 0% |
| IBM International Business Machines | $136.42 | $1.12 (0.83%) After 0.04% |
5 more rowsCons
- Dividends are not guaranteed. A company may decide not to pay dividends any further. ...
- Another con of dividend investing for passive income is the eventual ceiling of returns. ...
- Although companies with a very high dividend yield may seem appealing, they are extremely likely to reduce their dividend.
Dividend traps can be explained as stocks that are both cutting their dividends and their stock price is falling as a result.
What is a good dividend yield? ›
What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.
How much of your portfolio should be dividend stocks? ›
There is no definite answer on how many dividend stocks you should own. But as a rule of thumb, we believe it should be at least 20 in addition to some ETFs and mutual funds. As a dividend investor you are not trying to put the world on fire but save for your “income” and retirement. Play safe.
What is the best platform for dividend investing? ›
Comparing the best platforms for dividend investing
| Platform | Type of platform | Minimum investment |
|---|
| TD Ameritrade | Brokerage | $0 |
| M1 | Robo advisor | $100 |
| Fundrise Full Fundrise review | Real estate | $10 |
| Mainvest | Lending | $100 |
1 more rowYou can expect an investment portfolio to pay out dividends roughly between 1% to 6% of its value each year.
How do you live off dividends? ›
To live off of dividend income alone, you need to receive enough dividend payments each year to cover your expenses. Once you know how much income you need to cover your expenses, you can divide that by the average dividend yield of your portfolio to get a rough estimate of how much you need to invest.
Why should you avoid dividends in stocks? ›
It's prudent to focus on long-run total return, rather than income only. Dividends -- either reinvested or taken in cash -- lead to a higher tax bill. Dividend-paying stocks carry unsystematic risk, which could otherwise be diversified away.
Once you hit your 40s, though, it's a good time to start looking for bargains on great dividend stocks. As you pass through your 40s, you can gradually increase your holdings of high-dividend stocks and cut back on the riskier, more volatile growth investments.
What is the safest highest paying dividend stock? ›
Top 25 High Dividend Stocks
| Ticker | Name | Dividend Safety |
|---|
| VZ | Verizon | Safe |
| T | AT&T | Safe |
| ENB | Enbridge | Safe |
| MAIN | Main Street Capital | Safe |
6 more rowsMay 5, 2023
The Ideal Portfolio To Make $1,000 Per Month In Dividends
Each stock you invest in should take up at most 3.33% of your portfolio. “If each stock generates around $400 in dividend income per year, 30 of each will generate $12,000 a year or $1,000 per month.”
How do millionaires live off interest? ›
Millionaires have many different investment philosophies. These can include investing in real estate, stock, commodities and hedge funds, among other types of financial investments. Generally, many seek to mitigate risk and therefore prefer diversified investment portfolios.
Is dividend investing better than real estate? ›
Qualified dividends are taxed at the same rate as long-term capital gains. Even so, capital gains and dividend taxes are usually a much smaller tax bill than real estate taxes. And, there are tax-advantaged accounts that dividend investors can utilize to shield themselves from taxes, such as the Roth IRA.
Why I only invest in dividend stocks? ›
They are tax advantaged, when compared to some other forms of income, such as interest on fixed-income investments. Dividend-paying stocks, on average, tend to be less volatile than non-dividend-paying stocks.
How much money do you need to make $50000 a year off dividends? ›
According to Forbes, they typically pay measly yields of around 1.5%, which means you would need about $4 million to earn $50,000 a year in dividend payouts.
How much to make $2,000 a month in dividends? ›
To make $2000 a month in dividends you need to invest between $685,714 and $960,000, with an average portfolio of $800,000. The exact amount of money you will need to invest depends both on time, dividend growth, dividend reinvestment, and the dividend yield of the stocks.
How much to make $5,000 a month in dividends? ›
In order to make $5000 a month in dividends, you'll need to invest approximately $2,000,000 in dividend stocks. The exact amount will depend on the dividend yields for the stocks you buy for your portfolio. Take a closer look at your budget and decide how much money you can set aside each month to grow your portfolio.
Can you live off dividends of $1 million dollars? ›
If your portfolio produced an average dividend yield of 4%, a nest egg of $1 million would generate $40,000 per year in dividend payments. That might be enough for you to cover expenses in a very low cost of living area with a frugal lifestyle, but for many people, it's not enough.
Dividends can be classified either as ordinary or qualified. Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates.
How to invest $100 000 to make $1 million? ›
Invest $400 per month for 20 years
If you're earning a 10% average annual return and investing $400 per month, you'd be able to go from $100,000 to $1 million in savings in just over 20 years. Again, if your actual average returns are higher or lower than 10% per year, that will affect your timeline.
Can you become a millionaire from dividend stocks? ›
Can an investor really get rich from dividends? The short answer is “yes”. With a high savings rate, robust investment returns, and a long enough time horizon, this will lead to surprising wealth in the long run. For many investors who are just starting out, this may seem like an unrealistic pipe dream.
What are the top 5 dividend stocks to buy? ›
10 Best Dividend Stocks To Buy Now
| Dividend ETFs | Dividend Yield |
|---|
| Lockheed Martin Corporation (LMT) | 2.7% |
| Merck & Company, Inc. (MRK) | 2.6% |
| Air Products and Chemicals, Inc. (APD) | 2.6% |
| Automatic Data Processing, Inc. (ADP) | 2.4% |
6 more rowsJun 1, 2023
In most cases, stock dividends are paid four times per year, or quarterly. There are exceptions, as each company's board of directors determines when and if it will pay a dividend, but the vast majority of companies that pay a dividend do so quarterly.
What is the 4 dividend rule? ›
The 4% rule is easy to follow. In the first year of retirement, you can withdraw up to 4% of your portfolio's value. If you have $1 million saved for retirement, for example, you could spend $40,000 in the first year of retirement following the 4% rule.
Why are dividends disappearing? ›
Their analysis indicates that this dramatic change in dividend practices is due both to changes in the population of firms that are now publicly held (with many more public firms now exhibiting the characteristics of firms that historically have not paid dividends), and to a reduced propensity to pay dividends by firms ...
What makes a dividend king? ›
Dividend kings are stocks that have raised their dividend for at least 50 consecutive years. Dividend kings have survived periods of inflation, commodity booms and busts, rising interest rates, recessions, market crashes, changing consumer tastes, technology advancements, and more.
Is a 3% dividend yield good? ›
The dividend yield ratio is the ratio between the current dividend of the company and the company's current share price – this represents the risk inherently involved in investing in the company. Investors seeking income from dividend stocks should maintain their concentration on stocks with at least a 3%-4% yield.
Is a 7% dividend yield good? ›
Anywhere between 2% and 6% can be considered a good dividend yield. A typical S&P 500 dividend yield in 2023 is between 1.61% and 2.09% — so a yield over 2% could be considered above average.
A good dividend yield is high enough to meet your current dividend income needs. But low enough to suggest a company's dividend is not at risk. Dividend yields that meet these requirements will typically fall between 2% and 5%.
How to make $500 a month in dividends? ›
Dividend-paying Stocks
Shares of public companies that split profits with shareholders by paying cash dividends yield between 2% and 6% a year. With that in mind, putting $250,000 into low-yielding dividend stocks or $83,333 into high-yielding shares will get your $500 a month.
How much do I need to invest to live off dividends? ›
Close the gap with whatever retirement income you already have and if the number is lower than that $100,000 — say, just $10,000 — you'll be in better shape to experience dividend-derived freedom. To hit the $10,000 mark, you'd need roughly $427,000 at a 2.34% return.
Is a dividend portfolio good for retirement? ›
One way to enhance your retirement income is to invest in dividend-paying stocks, mutual funds, and exchange traded funds (ETFs). Over time, the cash flow generated by those dividend payments can supplement your Social Security and pension income.
Is dividend investing good for retirement? ›
Dividends are particularly valuable in retirement because they provide a consistent stream of income that can help cover living expenses. And, unlike bonds, dividend stocks offer the potential for capital gains as well as income. That means your portfolio can continue to grow even as you withdraw money from it.
Why avoid dividends? ›
Dividends generate taxable income
Depending on the underlying stock and how long you've held it, you might be taxed federally at long-term capital gains rates (anywhere from 0% to 20%) or at ordinary income rates (between 10% and 37%). You also have no control as to when a dividend is paid, or if it's paid at all.
How much do I need to invest to make $300 a month in dividends? ›
These passive-income powerhouses average a 9.73% yield, which means an initial investment of $37,000, split equally, would net you $300/month in dividend income.
How much will I have if I invest $500 a month for 20 years? ›
Length of Investment
For example, an investor who holds their portfolio for 10 years will put $60,000 into it (10 years of investing x 12 months per year x $500 per month), while an investor who holds the same portfolio for 20 years will contribute $120,000 worth of capital.
Is it risky to live off dividends? ›
Living off dividends amidst volatility is challenging but achievable. With preparation, knowledge, and wise portfolio diversification, returns may offset risks. It is important to be familiar with dividend-paying stocks and other investments.
How big of a portfolio do I need to live off dividends? ›
For example, say I need to earn $50,000 a year to live comfortably and my average dividend yield is 5%. So, I would need to own $50,000 / 0.05 = $1 million worth of shares to meet my income needs.
