Why Dividend Income Is The Holy Grail
Experienced investors understand dividends as the cash payments issued to shareholders quarterly, semi-annually or annually. For the novice investor or those looking to begin their investment journey, dividends can be viewed as a passive income stream. It’s simple, business cash flow equals individual income.
Companies that pay out steady dividends over time and are consistently raising their payments show strong performance and a valuable business. However, just because a business isn’t shelling out dividends it doesn’t mean it lacks profitability. A company may feel reinvesting profits can lead to further growth.
Dividend investors seek companies with high dividend yields in order to receive higher cash payments per share. Dividend yield is calculated as the annual dividend income per share divided by the current share price. Knowing the dividend yield will show you how much dividend income you can receive based on the amount of shares you own.
Investing in dividend paying stocks not only provides you with a strong business in your portfolio – in most cases, but also creates a passive income stream. Seeing that routine cash payment in your account is an awesome feeling and potentially an increased amount each year you are a shareholder.
What investment provides residual income with little worry, while being an owner of a great business who sits on the sideline? Here are 6 reasons why dividend income is the holy grail:
1. Strong Companies Grow Dividends Regularly
When it comes to blue chip stocks, more than often the annual dividend payouts will increase. Blue chips are large, strong reputable companies that are financially powerful. Companies such as Coca Cola, have increased annual dividends every single year since beginning its issuance in 1962.
2. Reliable Passive Income
For those companies that are well established and consistently payout dividends, investors can depend on them for routine income. It’s rare for a blue chip stock to cut dividends. Companies typically issue payouts on a quarterly basis, but there are some that disburse on a monthly, semiannual or annual basis.
3. Bear Market Love
At times of a struggling economy, the market can begin to see falling stock prices across the board. A bear market occurs from pessimism and heavy selling from investors. It is often measured as a 20% drop in stock prices throughout the major indices. The market won’t interrupt scheduled dividends and can soften the current lows of falling prices.
4. Reinvestment Options
Most brokerage firms allow for investors to reinvest their dividends into more stocks without having to pay a commission. This is an excellent way to jump into more stock positions if your funds are low, when it doesn’t make a lot of sense to take on trade fees. Also, reinvestment programs can be set up for automatic trades for specific stock picks.
5. Compounds Investment Returns
Potentially the best reason for dividend stock investing is the extra earned cash on the investment throughout its holding period. If a stock is held long-term, all the dividends earned can be rolled into the overall return of the investment. When reinvesting those dividends into the same stock over time, it builds on the value of the position and continues to compound its worth as well.
6. Reduced Income Tax
For US stock holdings there are tax benefits for the dividend income earned. The tax rate on your dividend income is determined by the level of taxable income you’ve earned for the year. For those in the 10% or 15% tax bracket, there is zero taxes owed on dividends. In the tax brackets of 25% through 39.6%, your dividends are taxed at 15%. And 20% for those with income above the 39.6% tax bracket.
Imagine every time you see someone pop open a bottle of a Coca Cola brand beverage, your dividend payment is linked to it. Essentially that is what happens, but at a very low scaled level. The greater the amount of shares owned, the larger the dividend payment will be. Paying attention to the dividend yield for a particular stock in comparison to its competitors may show its position within that industry.
‘Sum It All Up’
Well established companies provide a reliable source of residual dividend income and more than often increase their payments over time. Bear markets don’t stop dividend payouts, so any price drops can be offset by your dividends. Reinvesting the cash payouts into more stocks will only propel the compounding effect of investing, without having to pay trade commissions. Dividends are one of the few income streams that have a reduced tax rate from your normal wage income.
Image by Frank Wittig