Nov 14, 2022

What Is Dividend Investing and How Does It Work?

One of the finest methods to invest is by purchasing the shares of firms that consistently pay dividends. Some could even describe dividend investing as dull because you're making investments in more established companies for gradual, dependable payments. However, consistent gains are never monotonous. More in this blog!

What Is Dividend Investing?

One of the finest methods to invest is by purchasing the shares of firms that consistently pay dividends. Some could even describe dividend investing as dull because you're making investments in more established companies for gradual, dependable payments. However, consistent gains are never monotonous.

There are still many advantages to a dividend investing approach, even if earlier generations of investors preferred it since they generally received bigger yields than are currently available.

Read more: 10 Simple Ways To Improve Your Money Management

First things first, what is a Dividend?

A "dividend" is a payment made to shareholders when a portion of the company's profit is distributed to them. Each time a dividend is paid, it must be declared or approved by the board of directors of the firm. 

When investing in dividends, there are four dates to keep in mind:

  • Declaration date: When the board of directors declares its intention to pay a dividend.

  • Ex-dividend date: Any shares purchased after this date will not be eligible for the declared dividends, as set by the stock exchange. They would be eligible for the upcoming dividend round.

  • Date of record: This day is always the day after the ex-dividend day. It is the day that the stockholders must be included in the company's records in order to be qualified to collect the dividend for that period. It basically marks the company's ex-dividend date, whereas the prior date was related to the exchange itself.

  • Date of payment: This is the day the company's shareholders will actually get their dividend.

Different Types of Dividends

It is up to the discretion of the company whether dividends are paid in cash, more stock shares, or any combination of the two.

  • Cash Dividends: When a firm has a positive cash flow, it can distribute a portion of those profits to its shareholders on a regular basis in the form of cash dividends. Before any money can be distributed to the common stockholders, the preferred stock dividend must be paid. Most firms are cautious to raise or lower the dividend on their common stock for reasons that will be explained in further detail below.

  • Stock Dividends: A pro rata distribution of additional shares of a company's stock to owners of the common stock is a dividend paid in stock shares rather than cash. A corporation may decide to pay stock dividends for a variety of reasons, such as having insufficient cash on hand or wanting to reduce the price of the stock per share to encourage more trading and boost liquidity (i.e., how quickly an investor can turn their holdings into cash).

  • Property Dividends: Instead of paying out a dividend in the form of cash or stock, a firm may choose to give shareholders a piece of tangible company property. When calculating dividends from property, the current market value is used. They can be anything of material worth, from train carriages to cocoa beans to pencils to gold and silver to salad dressing.

  • Special One-Time Dividends: Occasionally, a business will issue a one-time dividend in addition to its normal dividend payments. These are extremely uncommon but can happen for a number of reasons, such as the successful resolution of a large legal dispute, the sale of a business, or the liquidation of an investment. Dividends can be paid out in the form of money, shares of stock, or even real estate.

Are Dividend Investing Profitable?

As long as you choose wisely when you buy, investing in dividend-paying companies can pay off in the long run.A "DRIP," or dividend reinvestment plan, may exist at some businesses. If you have a DRIP, you can decide whether to take your dividends as cash or reinvest them to acquire new shares. When your dividends are low—either because the firm is expanding or because you don't own a lot of stock—this can be a smart strategy.

Tax Benefits for Dividend Investing

For income investors, dividend investments can offer significant tax benefits. The Internal Revenue Service (IRS) does not, however, treat all dividends equally. 

There are two types: 

  • "Qualified" or "ordinary" dividends: which are taxed at the higher standard income rate.

  • "Unqualified" or "ordinary" dividends:  which are taxed at the lower long-term capital gains rate.

The majority of dividends paid by American businesses are eligible dividends. This means that dividend income is taxed at the long-term capital gains rate if investors own the stock for 60 days (which is typically the case). Other dividends, such as those from master limited partnerships (MLPs) or real estate investment trusts (REITs), are frequently categorized as ordinary dividends and subject to normal income tax. Ordinary dividends are also paid on money market funds and other cash-like investments.

Individual retirement accounts (IRAs) and 401(k)s are examples of tax-advantaged retirement accounts where dividends are normally not taxed until you remove the funds. 

To reduce your tax liability, seek out "qualified" dividends. Most dividend income is taxed at the lower capital gains tax rates, but qualifying dividend equities held for longer periods of time (often 60 days or more) qualify for these rates. You will be subject to your regular tax rate if you purchase stocks solely for the purpose of receiving the dividend payment and then immediately sell those same equities.

Vincere Tax believes in the optimization strategies that enable their clients to decrease their tax liabilities while allowing them to focus on what matters most: aligning their resources with their goals.

If you have any questions about the strategies discussed or want to work with Vincere, please feel free to reach out to them here.

Business Owner Tax Benefits

The Tax Cuts and Jobs Act that passed in 2017 introduced a 20% qualified business income deduction. It includes pass-through income from REITs, which is paid out as dividends. If you meet certain holding-period requirements on companies that pay out these types of dividends, you will see them labeled as "Section 199a" on your 1099-DIV. That means they're eligible for this qualified business income deduction.

Read more: 5 Tax Saving Strategies for Business Owners

Strategies for Dividend Investing

Most of the time, good dividend investors focus on either a strategy with a high dividend yield or a strategy with a high dividend growth rate. Each one has a different role in a portfolio. For example:

With the high dividend yield strategy, the focus is on companies that grow slowly but have a lot of cash coming in. This lets them pay out big dividends, and it could give you a way to make money right away.

  • Using the high dividend growth rate, you should focus on buying stock in companies that pay low dividends but are growing quickly. This means that you buy good stocks at a lower price and make a lot of money over the next five or ten years. 

Some investors might like one method better than the other. It all depends on whether you want a steady income right away or if you'd rather make money and grow over time. Choose a method based on how much risk you are willing to take. Consider how long you are willing to wait for your dividends to bring in the amount of money you want.

When are Dividend Payments Made?

Although quarterly dividend payments are the norm for most dividend-issuing firms, neither a regulation nor a necessity apply to that schedule. Companies are typically not required to distribute dividends, with the exception of real estate investment trusts (REITs). The majority of businesses are free to choose whether and when to pay dividends, and just because they have in the past doesn't indicate they will in the future. The exception is REITs, which are required by law to distribute the majority of their taxable revenue in the form of dividends at least once a year.

Is Dividends Investing Considered Safe? 

A simple calculation involves contrasting profits with dividend payouts. Companies that distribute less than 60% of their profits as dividends are generally safer investments. The degree of danger or novelty in a sector can also affect dividend security. A company's dividend payment may be less secure even if it has a low dividend payout ratio if the industry is volatile.

Try to find businesses that have maintained consistent cash flow and income throughout time. The payout ratio can be larger if dividend payments are more assuredly covered by earnings.

Things to Be Wary Of When Investing In Dividends

Dividend investment is no different from other investing strategies in that it entails risk. The fact that dividends are never guaranteed poses the biggest danger. Companies can and often do cut or even stop paying dividends.

There are other, more subtle hazards, though. Any investor should always prioritize diversification, and someone who places an excessive amount of emphasis on dividends is likely to overlook certain industries and business categories that are essential for effective diversification. For instance, young, rapidly expanding tech companies typically don't pay dividends.

Investors are consistently exposed to higher volatility when they lack diversity. Investors that focus primarily on dividends may miss out on high-value growth in industries that don't always pay dividends or pay them at low rates.

Are you interested in dividend investing, speak with an advisor at Vincere Wealth to find out if this suits your portfolio today.

I hope this was helpful! 



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