Investing in dividends could be the smartest move of your life, be it at 20 years of age or 50 years of age.
How so? Well, that’s what we’ll explore in detail in this guide. But before you read any further, it’s important to familiarize yourself with the basics of dividends.
You can only benefit from any investment type if you educate yourself on how it works and what a wise, safe, and calculated decision looks like in its respective domain.
Let’s get started!
Basics Of Dividends
A dividend is a share of the profits that a company pays to its shareholders. These shares or portions from the company’s earnings may be distributed on an annual, quarterly, or semi-annual basis.
There are two main types of dividends:
Cash-based dividends usually have a predetermined value. For example, XYZ company can offer one share for $0.25. If you own 100 shares, you’ll have a dividend of about $25.
Note that this is your dividend’s value. It’s not a return on investment (ROI). The ROI depends on the company’s profits.
Similarly, if a company pays in stocks, it will give you a greater amount of shares when it makes profits. The shares will be reinvested.
In the case of shares, you might start with ten shares, for example. In five years, you may own a total of 100 shares. At any point during this timeline or beyond, you can sell the shares and acquire their monetary compensation.
The most important thing to consider when investing in company dividends is the dividend yield. It is calculated by the following formula:
Annual dividends per share/price per share
The ideal dividend yield lies between 2-5 percent. So, when buying shares, make sure you evaluate the dividend yield trend of the company.
Usually, established companies offer stable and promising dividends. Small businesses and startups may offer shares at low prices, but they come with minimal and risky returns as well. You can explore the pros and cons of dividend yield and invest in dividend stocks with HALO Technologies here.
4 Reasons Why You Should Consider Investing In Companies
Now that you have a sound understanding of the basics of dividends, let’s explore its benefits. These are:
1. Guaranteed Increase In Value
Dividend-paying companies promise increased value every year or every quarter as their business grows. The individual prices of shares continue to rise, and so does the corresponding profit.
At times, businesses may not meet set goals or might suffer a loss due to external factors, such as inflation. In light of this, experts recommend considering the following factors to lower the risk of dividend investment:
Ideally, it’s best to opt for a low dividend yield when beginning your journey in dividend investment. The less you invest, the lower the risk.
The best strategy is to buy blue chip stocks (such as Coca-Cola, Apple, and Amazon) with a 1-3 percent dividend yield. The returns won’t be huge, but these investments will teach you about the market and its risks, along with making you a few bucks.
Long-Term Dividend Track Records
Just because a company sells massive amounts of goods doesn’t mean it’s financially stable. Check out the company’s annual dividends.
For the safest investment, you should look for the following:
- Dividend Kings: Increased dividend rate for at least 50 consecutive years.
- Dividend Aristocrats: Increased dividend rate for at least 25 consecutive years.
Dividend Payout Ratio
A company’s dividend payout ratio depicts its stability, free cash flow, and its measures for future payments. Most reliable companies offer a lower dividend payout ratio. Learn more about it here.
2. Taxed At Lower Rates
Legally, qualified dividends are taxed much lower than income from other sources. Here’s how the Internal Revenue Service taxes qualified dividends:
|Ordinary Income Tax Bracket||Corresponding Qualified Dividends Tax Bracket|
|35% – 37%||20%|
|12% – 35%||15%|
|10% – 12%||0%|
This means that if an individual with below-average income manages to save and invest in a dividend-paying company, they’ll have an asset they can reap 100% (with profits) when they get older.
Suggested Read: Everything You Need To Know About Federal Tax Calculator
3. Strengthens Investment Portfolio
If you’re a professional investor, dividends can be a great way to diversify your portfolio. You can do your homework and invest in shares from several different industries.
If gold collapses, you can count on your shares from the company that sells household goods. If Johnson & Johnson faces defamation and a decline in sales, you can count on Nestle. In this way, you’ll always have something to count on and will be safe from complete loss of investment.
4. Safest Capital Recovery
Dividends preserve your purchasing power, even if the company makes no major profits every year.
Imagine you invested $100 in 2005 in an ABC company. Although the company never skyrocketed its growth, it grew little by little. The dividend yield of the company went from one percent to three percent.
You withdrew your money in 2010, and by this time, there’s been inflation of two percent. Considering this exchange, you did not earn any major profits. But you did not lose your capital either.
The final cash you’ll receive will have approximately the same purchasing power as $100 back in 2005. You might have the same amount in your hands or slightly more, but you’ll never lose your purchasing power.
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