A few years back, I finally opened up anindividual retirement account, or IRA.
(A small step in investing, a giant leap toward adulting.)
After building my very ownportfolio, I noticed something interesting.
Every quarter, I found money paid into my account.
Theyre calleddividends, and dividend investing is an increasingly popular investment strategy.
How Dividend Investing Works
Adividendis money that a company pays regularly to its shareholders.
Its sort of like saying, Hey, thanks for investing in us, heres a little cash bonus.
Some people fancy dividend investing as a form ofpassive income.
If you invest enough money in a dividend-issuing company, you couldearn some serious income every quarter.
Most of us dont have enough to invest to make it that lucrative, but theoretically, its possible.
A company like Apple is generally managed toward increasing its share price hoping to provide growth in investment value.
So there may be a tradeoff here.
Every day you check your portfolio, and every day it is worth $100.
Then one day, the company pays a regularly scheduled $1 dividend.
You check your portfolio, and now you have $1 in cash.
But your stock is only worth $99.
Your total portfolio is still worth $100.
The dividend did not add to your portfolio value.
Of course, bond interest is guaranteed, he points out,but thats a whole other topic.
If you havent already picked up on it, theres a minor controversy here.
The Pros of Dividend Investing
Its like stepping on the gas of the compounding machine.
Each year youll wind up with more shares as the dividends are paid.
And as those dividends are raised, its like stepping on the gas of the compounding machine.
And if you need the income in the short term, there are options for that, too.
Lichtenfeld suggests perpetual dividend raisers for generating more income each year.
Other experts also argue that dividends are more dependable than a companys value.
Over the long-run, dividends are much more stable than earnings or cash flow.
Most companies that pay dividends want to gradually increase those dividends over time.
Beating inflation, solid growth, compounding returns….these are all solid reasons for dividend investing.
Despite that, there are just as many experts who argue against it.
Even if you have a $500,000 dividend stock portfolio yielding 3% thats only $15,000 a year.
Remember, the
safest withdrawal rate in retirement does not touch principal
.
And that can take time.
Youll be hoping for filet mignon for decades while you eatHamburger Helperin the meantime.
If Im going to bother taking risk in the stock markets, Im not playing for crumbs, hecontinues.
Fair enough: Who wants crumbs?
Theres also that tradeoff we mentioned earlier.
AsInvestopedia explains,Any money that is paid out in a dividend is not reinvested in the business.
Finally,Money magazineargues that dividend stocks have simply gotten too expensive to be worthwhile.
This makes it less likely that dividend payers can continue to produce market-beating returns.
It might be better, the writer argues, to look at companies thatarewilling to reinvest in themselves.
The money you earn from a dividend can either be taxed as a qualified dividend or as ordinary income.
(Thats for 2017 at least.
For 2018, the top rate will be 37%.)
So what makes a dividend qualified?
You also have to own shares in the company for more than 60 days of the holding period.
If its not qualified, that means its taxed as ordinary income, at your 35% rate.
Of course, that also typically means you cant touch the money until retirement.
Otherwise, you might choose to reinvest the dividend.
Thats because stock dividends arent usually taxable until the stock is sold.
And the tax hit can offset some of the lucrativeness of a dividend.
But if you dont,heres a primer.)
For example, the yield for General Motors is 3.47%.
How does that compare to other companies?
As a general rule, though, most dividend investors recommend a yield of about 4-6%.
Dividend Growth
Yield isnt the only metric, of course.
Simply investing in a stock because it has a high dividend yield is problematic, Johnson says.
As some stocks with very large dividend yields are likely to have unsustainable dividend levels.
Growth is another key metric in deciding whether a dividend is worth it or not.
Remember, Lichtenfeld and other experts recommend companies that increase their dividends every year.
Use that same website,Dividend.com, to look up the dividend growth.
Johnson suggests that dividend investors look beyond yield and start with stocks that have stood the test of time.
Dividend Payout Ratio
Pay attention to another metric calleddividend payout ratio.
This measures the percentage of profits a company pays yearly to its shareholders.
Also,Investopedia even points out that,historically, low payout dividend stocks perform better.
Look for Dividend Funds
Picking individual stocks is tough, though.
Its also risky if you dont know what youre doing (and most of us dont).
It also kind of goes against the old Warren Buffett strategy of set and forget investing.
you’re free to have the best of both worlds with dividend funds.
Morningstar lists a few solid oneshere.
Instead of dividend yield, look for the term distribution rate.
Even if you go with a fund, its useful to be familiar with the above key metrics.
Like most investing strategies, dividends can get really complicated really fast.
If you break it down, though, its fairly easy to get startedassuming you think its worth it.
