Yes, dividend stocks can be worth it if you evaluate your goals and determine whether they make sense for your particular needs. Reinvested dividends, which means that you put the rewards a company offers right back into your portfolio, can compound and increase growth further. In today's market conditions, dividends can make a big difference in your portfolio.
As you walk through all of your investing options, it may seem overwhelming because there are so many different directions you should go. Should you dive directly into stocks you like, such as the FAANG stocks you hear so much about — the tech titans Facebook, Amazon, Apple, Netflix and Google? Should you stick to investing in ETFs or even investing in real estate or REITs?
So, are dividend stocks worth it? Let's walk through exactly what they are and reasons why they're worth investing in, as well as reasons to consider not investing in dividend stocks. We'll also walk you through how to follow through with your purchase. Let's get started.
What Are Dividend Stocks?
First, what are dividend stocks, exactly?
Dividend stocks are stocks that pay out dividends, which usually come in the form of regular cash payments. Companies often pay out dividends to investors for the purpose of rewarding them for "sticking with" the company — in other words, they share their profits with investors. You might benefit from regular income through dividends, such as through quarterly or annual dividends and sometimes through special dividends.
Special dividends mean that the company may pay out a dividend if it experiences a great year or great quarter. Companies that do pay out dividends can often offer their investors stability. It's important to note that not all companies pay dividends, however.
Reasons Why Dividend Stocks Are Worth It
Why might you want to invest in dividend stocks? Let's walk through the reasons why you may want to invest in dividend stocks.
Reason 1: They provide a hedge against inflation.
During wobbly markets, dividend stocks allow you to have a steady income stream, particularly during times of inflation. Inflation, a decrease in the purchasing power of money, also means that the prices of goods and services in the economy increase. Dividend-paying companies can help you outpace inflation because you'll typically invest your money in more well-established companies.
They also reduce risk in your portfolio because dividend-paying stocks generally outperform non-dividend-paying stocks.
Reason 2: You'll benefit from growth and profits.
Solid companies like the Dividend Aristocrats or Dividend Kings have increased their dividend payouts for more than 25 years and 50 years, respectively. They offer a double benefit because you'll receive regular income from dividend payments as well as the capital appreciation on the stock. You can also reinvest dividend payments to buy more shares of stock in your investments. Each dividend you reinvest means that you'll keep collecting future dividend payouts.
You'll enjoy income and a slow, steady share price growth, which means they coild be safer investment options — a great option if you're a risk-averse investor.
Reason 3: You can benefit from tax advantages.
Qualified dividends are taxable at the federal level at the capital gains tax rate, which means that they depend on your modified adjusted gross income (AGI) and taxable income (the rates are 0%, 15% and 20%). You'll get a lower tax hit on qualified dividends compared to ordinary income.
Qualified dividends are taxed at lower rates than ordinary income. Ordinary income tax rate can go up to 35% or 37%, while individuals whose ordinary income tax rate is below 12% to 35% are taxed at 15%. Individuals who fall into the 10% or 12% tax brackets will not pay any tax on qualified dividends.
Reasons to Consider Not Investing in Dividend Stocks
Now, let's walk through the reasons to not consider investing in dividend stocks.
Reason 1: Taxes can stymie your growth.
While we just mentioned that you can benefit from tax advantages, you'll still pay taxes every single year you receive dividends, even if you're holding your dividend-paying investments longer than one year to get better tax treatment. You'll receive a tax bill for those dividends.
Reason 2: High-yield dividend traps can occur.
Watch out for high-yield dividend traps! If a dividend yield is high, it might signal that something is wrong with the company. Any money paid out to investors doesn't go toward the company.
You can determine dividend yield by dividing the yearly dividend payment and dividing it by the stock price. In other words, let's say a company pays you $2 in dividends per year and the stock price is $100, you'll see a dividend yield of 2%.
To combat choosing a company with a too-high dividend yield, you'll need to consider a wide variety of company fundamentals before you decide to invest in a particular company.
Reason 3: Income isn't guaranteed.
While some companies have excellent track records with dividends, they can still become reduced or disappear altogether. When cutbacks in the dividend occur, the share price can also suffer as well. A dividend cut can affect both the company and its shareholders when markets react negatively to a company's dividend.
Are there other downsides and upsides to investing in dividend stocks? Of course! Ultimately, you have to determine whether dividend stocks make the most sense for you based on your risk tolerance, goals and investment timeline. They aren't right for every investor!
How to Assess the "Right" Stocks
So, knowing these pros and cons, how do you choose the right dividend stocks for your needs?
Step 1: Look into the fundamentals.
Take a look at as many factors as you can unearth — the company's history, stock price, profitability, market size, management and more. Calculate the dividend yield based on the share price and the dividend payout ratio, which examines the full percentage of a company’s earnings that are returned to shareholders as dividends.
Look for companies and stocks with a dividend yield of 4% or higher, a dividend payout ratio between 50% and 70% and a strong history of dividend growth. (In other words, companies with a long history of financial stability and low volatility which can handle market fluctuations).
Our Dividend Kings vs. Aristocrats article can help you narrow down a list of quality stocks or consider some popular sectors, such as utilities, energy, consumer staples and other types of sector-based stocks. You may also want to consider purchasing a dividend stock ETF so you don't put all your eggs in one basket with one stock (which you should never do anyway because it doesn't offer enough diversification).
Step 2: Review stock quotes and purchase.
How much do you want to pay for a dividend stock? Your budget may limit how many shares you can purchase during a particular time. If you can't purchase as many shares of a stock immediately, remember that you can always take advantage of a dividend reinvestment plan (DRIP), which means you reinvest your dividends into new stocks.
You'll need to have a brokerage account in order to purchase a stock, though it is possible to buy a stock directly through the company through a direct purchase program. However, not every stock is available to you with a direct purchase program.
Once you've identified your brokerage account and the number of shares you plan to use, you'll add the number of shares you want to your account and name your order type. You have a few options, including a market order, or an order to buy or sell a stock at the best available price; a limit order, or a request to buy or sell at a specific price or better; a stop-loss order, or an order that once a stock gets to a certain price, a market order begins and the order is filled at that price. A stop-limit order means that once a stock reaches the stop price, the trade turns into a limit order and fills to the specified price limits.
Your brokerage will be able to help you through the steps if you're not exactly sure how to execute your purchase.
Step 6: Consider reinvesting your dividends.
You could take payouts every year, but it's worth considering whether you want to reinvest your dividends, which will offer compounding and larger returns later on. Investing for retirement can be a great strategy because you'll take the payouts when you need them most.
Are Dividend Stocks Worth It?
Do you know why you might want to invest in dividend stocks? Dividend stocks might be worth it if you know they'll meet your exact goals and fit your timeline perfectly. On the other hand, you may decide that the payout isn't good enough per year based on a number of factors, including the fees you'll pay a brokerage to invest.
You may not want to go it alone. Consider talking to a fiduciary financial advisor (someone who has your best needs at heart) to determine whether dividend stocks make sense for your goals, horizon and risk tolerance.
You want to make sure that you're choosing the right avenues for your future.