What Is a Dividend?
Dividend-paying stocks are investments that pay out a portion of earnings to shareholders on a regular basis. For retirees, dividend-paying stocks can grow personal wealth and generate a stream of passive income. Dividends are usually distributed each quarter. They may be paid out in the form of cash or stock.
- Written by Lindsey Crossmier
Lindsey Crossmier is an accomplished writer with experience working for The Florida Review and Bookstar PR. As a financial writer, she covers Medicare, life insurance and dental insurance topics for RetireGuide. Research-based data drives her work.Read More
- Edited ByLamia Chowdhury
Lamia Chowdhury is a financial content editor for RetireGuide and has over three years of marketing experience in the finance industry. She has written copy for both digital and print pieces ranging from blogs, radio scripts and search ads to billboards, brochures, mailers and more.Read More
- Financially Reviewed ByBarbara O’Neill, Ph.D., CFP®, AFC®, CRPC®
Barbara O’Neill, Ph.D., CFP®, AFC®, CRPC®
Certified Financial Planner™ professional, Accredited Financial Counselor™ and owner and CEO of Money Talk
Barbara O’Neill is a personal finance expert with 41 years of experience working at Rutgers University. She is a Certified Financial Planner™ professional and an Accredited Financial Counselor™. Currently, she is the owner and CEO of Money Talk, where she writes, speaks and reviews content related to personal finance. In 2020, she authored Flipping a Switch, published in 2020.Read More
- Published: May 17, 2023
- Updated: July 10, 2023
- 9 min read time
- This page features 15 Cited Research Articles
- Edited By
- Dividend-paying stocks are investments that pay out a portion of earnings to stockholders on a regular basis.
- They are an effective way to generate passive income and build personal wealth.
- A diverse portfolio of dividend-paying stocks in different industry sectors can protect investments from market volatility.
How Do Dividends Work?
Dividends are company earnings that are paid out to shareholders in the form of cash or additional stock. Dividends are distributed monthly, annually or at the end of each financial quarter. Dividend stocks are especially suited to retirees since they not only help build personal wealth but can also serve as a source of regular, passive income – which can be a significant factor in retirement planning.
Dividend stocks can offer a stream of income, deliver capital gains and increase the overall value of a retirement investment account. This additional income can help supplement Social Security and other retirement benefits. Plus, if the stock value increases over time, so will the dividend payout.
Within a retirement investment strategy, dividend stocks – along with bonds, fixed-income securities and exchange-traded funds (ETFs) – are important elements in diversifying a retirement investment portfolio and protecting it from market volatility.
Investing in stocks also helps serve as a hedge against inflation. Since business revenue tracks consumer prices, a company’s income will naturally take inflation into account. Dividend payments and increasing stock value can help offset inflation’s effects on your money.
- Your money grows with the economy
- Invested assets stay ahead of inflation
- The potential to invest small or large sums of money
- Generates passive income from appreciation and dividends
- Increased income generates liquidity
- Easy to get started
Like any kind of investment, dividend-paying stocks are subject to changes in the market. Volatility can impact the value of an investment, and dividend stocks are no exception. It’s important to consider the risks included with dividend-paying stocks before investing.
- Stock values can go down
- With a decrease in value, stock dividends may become smaller or nonexistent
- If a company goes bankrupt, stockholders are the last ones to be paid out
- The risk of losing some or all of an investment
- Finding the right investments can take time to research
- Profitable stock sales are subject to tax
- Market volatility can be full of emotional ups and downs
How To Calculate Dividends
Calculating the value of dividend payments lets retirees estimate the potential returns they can expect from a stock purchase. It is an essential piece of information that can help you make informed investing decisions.
The dividend yield is a measure that investors use to calculate stock dividends and evaluate dividend-bearing stocks. It is a ratio or percentage that shows the amount of income that is earned in dividends for every dollar invested in that stock.
Dividend Yield Percentage x Stock Price Per Share = Dividend Per Share
For example, if a stock’s dividend yield is 1.66% and the stock price is $100 per share, owning one share of the stock will generate $1.66 in dividends. If an investor owns hundreds or thousands of shares, then the $1.66 dividend payout quickly turns into a sizable sum.
Remember that even if a company makes a profit, it does not mean all those funds will be distributed to shareholders. The board of directors of a company can decide to portion out earnings in several different ways. In some cases, they may decide to not pay dividends at all and instead reinvest them back into the company.
If they reinvest, it is typically to increase the value of the underlying stock, which hopefully turns into a capital gain (an increase in the value of the stock) for individual investors.
The company’s board of directors can also decide to pay investors in stock rather than cash.
The dividend policy of a company’s board of directors is based on several factors that have an effect on share price, growth and the company’s public profile. They must effectively decide how much money can be reasonably distributed as dividends to shareholders, and how much of their financial resources the business needs to deal with contingencies and ongoing expansion.
- Determine your investment goals, including your risk tolerance and time horizon.
- Sign on with an online broker or a full-service brokerage firm.
- Do your research and assess different companies in different industry sectors. Determine dividend yields and other important performance indicators.
- Buy dividend-paying stocks, bonds or ETFs.
- At the end of each quarter, the company's board will decide on the type of dividend payout and amount.
- You will receive your dividend payment on a fixed date.
- Consider reinvesting dividends through a DRIP program versus cashing out the amount. It’s important to be aware of different tax implications.
- Regularly re-evaluate the performance of investments.
- If performance is lacking or the industry sector is unstable, consider selling and buying another kind of stock.
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Types of Dividends
When we talk of dividends, we usually think of dividend payments in the form of cash or stock. Still, there are different types of dividend payments depending on the nature of the investment and the decisions of a company’s board of directors.
|Type||Description||How They’re Distributed||Why They’re Good for Retirees||Pros||Cons|
|Cash Dividends||Most common Distributed to shareholders through cash transfers||Usually distributed quarterly, but some companies opt for monthly or annual lump-sum payments||Source of passive income and capital gains||If you reinvest the dividends, you’ll continue to grow your wealth||Even if reinvested, dividends may be taxed|
|Stock Dividends||Companies choose to pay dividends as shares instead of cash||Usually distributed quarterly, but some companies opt for monthly or annual lump-sum payments||Investor potentially has more shares to sell in the future.||Dividend stocks are usually offered by relatively stable companies||Investing in dividend stocks may cost more than other investments|
|Property Dividends||Less common Companies pay out by giving assets or inventories to shareholders||Usually a one-off payment||Companies use the fair market value of the asset to determine how much a shareholder should receive||Non-cash dividends may allow you to lower your tax bill||Companies may opt for property dividends if they don’t have cash available to pay regular dividends|
|Special Dividends||A dividend payment that is outside of the typical dividend cycle||Usually a one-off payment||A sign that a company has had an exceptionally strong earnings period||Gives extra profit to shareholders||Because they are non-recurring, you can’t build your retirement strategy around special dividends|
How To Invest In Dividend Stocks
Dividend stocks can be individual stocks or a group of stocks pooled into specific mutual funds or ETFs. In the case of funds, the dividend payments are paid out to the fund and then distributed to the funds’ shareholders.
No investment decision is risk-free. Investing in stocks, mutual funds or ETFs is about doing your homework. A sound retirement investment strategy starts with researching important information about the company or fund and then calculating risks and benefits so that you can make an informed decision.
- Open up a brokerage account with a reputable brokerage firm. Many options are available, from online discount brokers to full-service brokerage companies.
- Determine your investment goals, including your risk tolerance and time horizon.
- Research and evaluate different dividend-paying stocks. Determine dividend yield figures and other important indicators such as price-to-earnings and debt-to-equity ratios.
- Build a diversified portfolio across several sectors to reduce risk and increase potential returns.
- Reinvest dividends. Take advantage of dividend reinvestment plans (DRIP).
- Make sure to monitor portfolio performance. Keep track of dividend payments, stock price changes and news or events that might impact the value of your investments.
- Reevaluate your portfolio on a regular basis to maintain your risk profile and asset allocation. This might involve selling off and buying new stocks, or adding or removing funds from a dividend-focused ETF or mutual fund.
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Taxation of Dividends
Dividends can be taxed as qualified or nonqualified. Nonqualified dividends are taxed at standard income tax rates, while qualified dividend payments are taxed at the more favorable capital gains rates.
Understanding which stocks pay out qualified or nonqualified dividend payments is critical because of the tax implications – particularly if you are retired and on a fixed income.
Common stocks must be held for at least 61 days before the qualified dividend payment date, and 91 days for preferred stocks. A U.S. corporation must pay out the dividend. They then qualify for the lower capital gains tax rate in both cases.
If you are on Social Security, interest or dividends from savings and investments (along with pension payments and annuities) are not subject to Social Security taxes. However, they can be subject to income tax.
Everyone’s financial situation is different. It’s important to understand that if you want to benefit from a retirement investment strategy focused on dividend-paying stocks, it may be advantageous to consult a tax professional. This will help ensure that your investments are appropriate and provide you with peace of mind in the long run.
Editor Malori Malone contributed to this article.
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15 Cited Research Articles
- Singh, H. (2023, April 12). The 60-40 Investment Strategy Is Back After Tanking Last Year. Retrieved from https://www.wsj.com/articles/the-60-40-investment-strategy-is-back-after-tanking-last-year-b4892aac?mod=Searchresults_pos11&page=1
- IRS.gov. (2023, April 4). Topic No. 404, Dividends. Retrieved from https://www.irs.gov/taxtopics/tc404
- Saunders, L. (2023, March 31). How You Can Grab a 0% Tax Rate. Retrieved from https://www.wsj.com/articles/capital-gains-taxes-how-you-can-grab-a-0-tax-rate-1fcfac39?mod=Searchresults_pos6&page=1
- Pino, I. (2023, March 6). What Are Dividends? How They Work and Key Terms You Need To Know Before Investing. Retrieved from https://fortune.com/recommends/investing/what-are-dividends/
- Tamplin, T. (2023, February 28). Dividend Policy. Retrieved from https://www.financestrategists.com/accounting/cost-accounting/inflation-accounting/dividend-policy/
- Tretina, K. (2023, February 28). What Is Dividend Yield? Why Is It Important? Retrieved from https://www.forbes.com/advisor/investing/dividend-yield/
- Ashford, K. (2023, February 13). What Is Market Volatility—And How Should You Manage It? Retrieved from https://www.forbes.com/advisor/investing/what-is-volatility/
- Chin, S. (2022, April 13). Dividends can be paid in cash or in additional shares of stock. Here's the difference between the two types. Retrieved from https://www.businessinsider.com/personal-finance/stock-dividend-vs-cash-dividend
- InvestingAnswers.com. (2021, April 27). Inflation. Retrieved from https://investinganswers.com/dictionary/i/inflation
- Gray, T. (2020, October 8). Dividend Funds Can Add Income, and Risk, to Your Portfolio. Retrieved from https://www.nytimes.com/article/dividend-funds-portfolio.html
- The Economist.com (2020, May 28). What is the link between inflation and equity returns? Retrieved from https://www.economist.com/finance-and-economics/2020/05/28/what-is-the-link-between-inflation-and-equity-returns
- Investor.gov. (n.d.). Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends. Retrieved from https://www.investor.gov/introduction-investing/investing-basics/glossary/ex-dividend-dates-when-are-you-entitled-stock-and
- Financial Conduct Authority. (n.d.). Should you invest? Retrieved from https://www.fca.org.uk/investsmart/should-you-invest
- Investor.gov. (n.d.). Direct Investment Plans: Buying Stock Directly from the Company. Retrieved from https://www.investor.gov/introduction-investing/investing-basics/glossary/direct-investment-plans-buying-stock-directly
- Investor.gov. (n.d.). Exchange-Traded Funds (ETFs). Retrieved from https://www.investor.gov/introduction-investing/investing-basics/investment-products/mutual-funds-and-exchange-traded-2
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