You probably received financial advice before that says you should “make your money for you.” While there are many ways to do that, one of the most simple methods is through dividends. It’s a fairly simple concept that can play a significant role in your financial growth with very little effort on your part.
At Vital Card, we aim to equip you with the knowledge to make informed financial decisions and take firm control of your finances. In this article, we’ll take a closer look at dividends, how they can benefit you, and a few tips for getting started.
What are dividends?
Think of dividends as your share of a company's profits, handed over to you because you own some shares of stock. The way that dividends work is simple: The higher the number of shares that you own, the bigger your profits. It's like a thank you note from the company for investing in them, and it comes in the form of cash.
There are a few types of dividends, but they can be boiled down into two categories: Cash and special.
Cash dividends, the most common type, are like a steady paycheck from the company. They're regular payments made from the company's profits and are typically paid out on a schedule, much like your salary.
Special dividends, on the other hand, are more like surprise bonuses. These one-time payments happen under specific circumstances — for example, the company sells off a subsidiary or wins a big lawsuit.
How and when are dividends declared and paid out?
The company's board of directors is the team that gets the ball rolling. They're the ones who say when dividends will be paid and the dividend amount that each shareholder will get. This announcement is made on what's known as the declaration date.
The time frame for dividend payouts can vary from company to company. Some like to spread the love and pay out dividends monthly or quarterly, while others prefer annual dividends once the fiscal year has ended.
Here's the key part of the deal — dividends are paid out on a specific date, called the payment date. To be eligible for this payment, you need to be a shareholder on the record date. This means if you buy a stock after its ex-dividend date — which is the cut-off for getting on the “guest list” — you won't receive the next dividend payment. Instead, you'll have to wait for the following payment cycle.
How do you earn dividends?
The first step is that you'll need to become a shareholder in a company that pays dividends. It’s not something that all companies do so you’ll need to be selective on the stock market. When you find a good dividend-paying company, then you’ll need to buy dividend-paying stocks.
Within a company, you can buy different types of stocks — common and preferred. If you're looking to earn dividends, you'll want to focus on preferred stocks.
This is because preferred stocks come with a few exclusive benefits. For example, they're often prioritized over common stocks, meaning you're more likely to receive a high dividend payout if you own preferred stocks. Also, preferred stocks are often fixed at a certain rate, while common dividends can be changed or cut entirely.
What are the benefits of dividends and what should you do with them?
The beauty of dividends lies in the regular cash flow they provide. As a stockholder, these payments can be a steady source of income for you. That's not all — dividends can also give your total return a nice little boost. Think of them as a bonus on top of any profit you might make from selling your stocks at a higher price than you bought them.
What should you do with these dividends once you've got them? It’s your money, so you’ll be free to do whatever you want with it. However, one popular option is to reinvest them through something called a Dividend Reinvestment Plan, or DRIP for short.
Here's how it works: Instead of taking your dividends as cash, you use them to buy additional shares of the company stock. It's like rolling a snowball down a hill — the more you reinvest, the more shares you have, and the more shares you have, the more dividends you could potentially earn in the future, and so on. It's a clever way to potentially grow your investment significantly over time, even if you don't invest any more of your own money.
Do dividends have an impact on stock prices?
Yes, dividends can indeed make a move on stock prices. When a company's board declares a dividend, it's like shining a spotlight on their stock. It suddenly looks much more attractive to investors keen on a steady income stream. This uptick in demand can drive up the share price, giving a nice boost to your investment.
Here's where it gets more interesting. There's a special term for the relationship between the dividend payment and the share price — it's called the dividend yield.
Think of the dividend yield as a measure of bang for your buck. It tells you how much you're earning in dividends for every dollar you've invested in the stock. A high dividend yield typically means you're getting a good deal, especially if the company is stable and likely to keep paying dividends.
How are dividends taxed?
Unlike the rollercoaster of capital gains tax rates that you might encounter with stock trading, regular dividends are a bit more straightforward. They're considered taxable income, just like the wages from your job.
There's an interesting twist: Not all dividends are taxed equally. There are two types — qualified and non-qualified dividends — and they're taxed at different rates. Qualified dividends get a bit of special treatment and are taxed at a lower rate than regular income. This can make them a pretty attractive option for investors looking to maximize their after-tax returns.
How your dividends are taxed can also depend on the type of investment account you have. For example, dividends earned in a Roth IRA or a brokerage account might be taxed differently than preferred stock with a public company. It's always a good idea to consider your overall financial situation and maybe even chat with a tax advisor when dealing with dividend taxes.
Remember, dividends aren't just for individual stocks. Mutual funds and Exchange-Traded Funds (ETFs) can also dish out dividends to their shareholders. These types of investments can also offer a regular income stream with a little more security as your investment is spread out and not focused on a single company.
Tips for choosing a dividend-paying company
First off, history matters. A company with a long history of paying dividends proves their reliability and is often a sign of financial stability. These companies have weathered the stock market's ups, downs, and general volatility and still managed to reward their shareholders. That's a good sign and something worth investing in.
Next, you’ll need to closely examine a company's dividend payout ratio. This is the percentage of its earnings that it pays out as dividends.
A lower ratio could mean the company is keeping enough cash on hand for growth or to weather tough times, while a higher ratio could indicate a generous income stream for shareholders. However, you should be careful here as a ratio that's too high might mean the company isn't investing enough in its future and might not last for much longer.
Last, it’s important to remember that you don't have to go it alone. Services like Fidelity, TD Ameritrade, and Interactive Brokers can be a guiding hand in managing your dividend income. They can help you understand the twists and turns of finances, making your dividend investing journey and wealth management a little less bumpy.
Use Vital Card to jumpstart your financial journey
We've talked about the benefits of dividends: The regular income stream, the potential for a boost in total returns, and the tax advantages of qualified dividends. Of course, let's not forget the opportunity to reinvest these dividends to grow your investment over time. All in all, dividends can be an excellent investment opportunity for you.
Remember that Vital Card is here to empower you on this journey. Our blog is packed with easy-to-understand financial wisdom, including more insights on dividends, investing, and responsible spending.
We don't stop at just educating you. With Vital Card, you get to practice responsible spending and earn rewards that you can potentially use to purchase dividend stocks.
Join the waitlist for a Vital Card today and take the first step toward a more informed and rewarding financial journey. Let's make your money work harder together.
Sources
What is a Good Dividend Yield? How to Decide | Nasdaq
How Do Stock Dividends Work? | Experian
Mutual Funds and Exchange-Traded Funds (ETFs) – A Guide for Investors | SEC
What is a Dividend Payout Ratio, and What Does it Indicate? | Nasdaq
What Is Dividend Investing? | Experian
Qualified vs. Unqualified Dividends | Nasdaq
What Is Preferred Stock? | Experian
Ex-Dividend Date vs. Record Date: What’s the Difference? | Nasdaq
Vital Card blog posts are intended for informational purposes only and should not be considered financial or any other type of advice.