It’s no surprise that CD rates are super low and have been for a long time now. Per Bankrate.com, the best rates for a $10,000 5 year CD is 2.35%. I’ve seen so many stocks that have a higher yield. So if you’re looking for a little passive income, don’t look at CDs so much, but alternatively at dividend stocks.
Dividend stocks are generally offered by companies who have been around for many years, so they take their profits and pay them back to the shareholders. Established companies offer these more because they have reached a level of maturity in their business. And because of this maturity, product identification, customer base, they are able to offer dividends.
Maybe the Fed Can Help, Maybe Not
If the Federal Reserve starts the process of regularly raising the federal funds rate, this can help boost CD rates. But as this has not been happening, it is yet another reason to leave CDs in the dust and look elsewhere for higher returns.
Even if the Fed begins rate hikes on a more regular basis, this won’t necessarily make CD rates jump right away. Per Nerd Wallet, “Fed rate hikes don’t cause bank rates to skyrocket overnight, but they canencourage financial institutions to gradually increase their APYs.” It goes on to say that banks in the past have to raise loan rates instead of CD rates following a rate hike.
This chart I pulled from retirementincome.net shows the steady increase in dividend income VS CD interest income for a 40 year period:
High Yield Dividend Funds
Instead of dividend stocks, I’ll present dividend funds or ETFs rather. This is because you automatically get diversification too with these. Per http://www.dividend.com/dividend-etfs/, a few of these include:
- CVY – multi-asset income ETF with a yield of 4.4% and has been paying a divided for more than 10 years.
- DHS – market cap of over $1B with a yield of 3.07% and has been paying a divided for more than 10 years.
- PGF – market cap of over $1.5B with a yield of 5.6% and has been paying a divided for more than 10 years.
Of course, there are many other high yielding divided ETFs to choose from and other factors/variables to consider. By the way, I don’t own any of these. Do as I say, not as I do….just kidding J One more to add is:
- PFF – market cap of over $18B, with a yield of 5.62% and has been paying a dividend for about 10 years.
Is It Safer? No, But Hey No Risk No Reward
Since you may get a higher return, dividend funds do come with a bit more risk. The risks of high dividend stocks and funds include:
- Cut in the dividend, which means less income for you and a possible decline in stock price as well. That doesn’t happen too often though unless we are in an economic crisis. These days more and more companies are actually raising their dividends.
- Pressure to continuously raise interest rates which can result in money coming out of dividend stocks and falling stock prices.
- Nature of investment – dividends do not have to be paid, so a company can essentially cut or eliminate dividends. This is not the case with CD interest income.
- Depends what you buy – for example in the case of XLU – utility ETF that has a yield of 3.48%. Compared with the SPY index for the overall market, it has lagged overall as the S&P is up by ~20% in comparison.
More Money = More Taxes
Yes with dividend income you pay taxes. But remember paying taxes is good because it means you’re earning income. Depending on your income, you can pay either 0 or up to 20% tax on qualified dividends.
One way to strategize in a way to reduce your tax liability is to own high dividend paying stocks in tax-deferred accounts. As these continue to grow and reinvest, so will the amount of the dividends and that is when you can really benefit from the tax shelter in tax-deferred accounts in the short-term at least. These are usually 401(k) plans and IRAs. Motley Fool further explains that by eliminating the tax liability on these accounts, it can help your portfolio grow uninterrupted with dividend reinvestment and long-term gains.
At the same time, it’s also a good idea to have some dividend-paying stocks in after-tax accounts for flexibility.
You don’t want to pay a lot of taxes when withdrawing your retirement funds, do you? A company you own may also pay a stock dividend which is just a payment in the form of more stock from that company instead of a cash dividend. But you don’t have to pay taxes on these stock dividends until the stock is sold.
So do you have funds in a CD set to expire and are pondering where to deploy? Could a dividend stock or fund be a viable option? Got any good ones in mind you’d like to share?
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