Dividend stocks can be a useful way to build your investment portfolio as you work on building long term wealth. Plus, you may experience an income boost through smart dividend investing.Interested in adding dividend stocks to your portfolio? Let’s take a closer look at what you’ll need to know.
What are dividend stocks?
A dividend stock is a type of stock that provides two wealth-building opportunities. When you own a dividend stock, you can generate an income through dividend payments. Additionally, the stock may increase in value over time to bolster your net worth.Essentially, any stock can be a dividend stock if it provides a portion of the company profits to its shareholders through the use of dividends.
What is a dividend?
But what is a dividend? It is critical to understand exactly what a dividend is to see a clearer picture of what this type of stock can provide.According to the U.S. Securities and Exchange Commission, a dividend is a portion of a company’s profit paid to its shareholders.
A public company can choose to pay dividends on a regular schedule to its shareholders. However, the company can issue dividends or eliminate dividends at any point in time.For example, let’s say you own 100 shares in a company that pays a dividend of 10 cents per share. As an investor with 100 shares, you would receive $10 in cash.
Unlike a bond, a company is not legally obligated to provide regular dividends to its shareholders. With that, there is a risk that a company could eliminate or reduce the promise of dividends at any time.
How do dividend stocks work?
Dividend stocks can be used to generate an income immediately or build long-term wealth. Both sides of the equation are critical to a sustainable investment. The combination of the paid dividends and stock price is known as the total return.
Many investors enjoy the income-producing nature of dividend stocks, even though the dividends are never a guarantee. But it is important to consider the growth of the stock prices as well.As an investor in dividend stocks, you could receive dividends from the company based on the number of shares you own. Typically, dividends are paid out on a quarterly basis through the shareholder’s brokerage account. But each company will determine the payment date and method of payment on an individual level.
How to start investing in dividend stocks
If you are intrigued by the idea of investing in dividend stocks, here’s how to get started.
Research companies that offer dividends
As you start your search for the right company to invest in, you’ll find that many companies don’t offer dividends at all. With that, you can quickly cross those companies off your list.
In general, you’ll want to look for established companies with a reputation for financial stability and regular dividend payments. Although a record of regular dividend payments is not a guarantee of any future payments, it can indicate a more reliable investment.As you evaluate the investment opportunity within a company, consider the following indicators of success:
- Company’s track record. You want to invest in a company that has a long history of success.
- Debt. Although some companies can leverage debt in an appropriate way, too much debt is never a good thing. With too much debt on the books, the company will be forced to use profits to service that debt instead of paying the dividends you are searching for.
- Stock price. Consider whether or not the stock price is an accurate reflection of the company’s value.
- A company’s financial statements. Before you move forward with an investment, check out the financial statements of the company. Make sure that the company is financially solvent with an outlook for growth before investing.
Not sure where to start your search? Consider checking out our guide to investment terms to help you smoothly navigate the process of researching companies.
Open a brokerage account
You can make your investments into dividend stocks through a brokerage account. With the right brokerage account in place, you can make your purchase of dividend stocks.As you look for a brokerage account, find a platform that minimizes fees, and gives you plenty of investment options.
Reinvest through DRIP programs
When you start investing in dividend stocks, you can take advantage of the new income stream right away. But you can also use that new income stream to reinvest in the company and continue to build your investments.You can streamline the reinvestment process through a DRIP program - otherwise known as a dividend reinvestment plan. This is a simple solution to reinvest your dividends on a regular schedule.
Don’t overlook dividend stock funds
Researching individual dividend stocks can be time-consuming. Luckily, there is another option available with the help of dividend stock funds. Instead of spending all of your time researching individual companies, you can seek out a dividend stock fund that suits your risk tolerance and your investment goals.
Don’t forget about taxes
As you work to build this new income stream, don’t forget to factor taxes into your budget. Otherwise, you could be looking at an unfortunate surprise around tax time.In most cases, dividend stocks pay out ‘qualified’ dividends. Depending on your other income sources and current tax bracket, this income could be taxes somewhere between 0 to 20%. Take some time to determine how much you should save from your dividend payments to cover your tax bill at the end of the year.
Examples of the best dividend stocks
Not all stocks on the market offer dividends. In fact, many don’t. Companies that are growing quickly or strapped for cash are often unable to offer a cash dividend to investors because they need to reinvest the cash back into the company.
Typically, older and more established companies are able to offer dividends to their shareholders. However, even these more established companies that are known for offering dividends may have to skip a dividend payment in difficult economic conditions.Here are a few examples of popular dividend stocks:
- IBM. International Business Machines Corp.
- NWE. NortherWestern Corp.
- BOH. Bank of Hawaii Corp.
- AEP. American Electric Power Co Inc.
Don’t forget that you can choose to invest in dividend funds instead of individual stocks. A few popular options include:
- PRDGX. T. Rowe Price Dividend Growth Fund.
- VYM. Vanguard High Dividend Yield ETF.
- FDGFX. Fidelity Dividend Growth Fund.
As mentioned, these are simply examples. Take some time to research your options. Seek out the dividend stocks and funds that best suit your investment goals.
The bottom line
Dividend stocks can be a powerful way to build passive income and your investment portfolio. Although dividends are never a guarantee, this investment strategy can be worthwhile.
