What Is a Dividend?

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.

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.

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.

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.

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.

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.

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.