One of the best ways to build wealth is through investments in the stock market. Historically, the market has returned around 10% on average over the long haul. There are two major ways to make money through investing in stocks that do not involve complicated options contracts. The first is through the capital appreciation of each share of stock. The price of each share of a company can go up or down. Those who buy low and sell high can lock in a capital gain and make money. This is a popular way to make money through stocks. The second option for making money through the stock market is though dividend investing.
What Are Dividends?
Dividends are periodic cash payments that a company provides for investors. Dividends come from the free cash flow a business has available. Ideally, a company will have a solid flow of net income available before it begins to pay a dividend. Otherwise, keeping all available cash on hand to grow the business might be a better use of a shareholder’s investment. Most US-based companies pay out dividends on a quarterly basis although there are a few that pay monthly, semiannual or annual dividends.
Benefits of Dividends
Primarily investing in companies that pay dividends will provide a couple of major benefits for investors. First, dividends can provide a relatively reliable stream of income. As long as a business has strong fundamentals with stable or growing revenue and income numbers, it can continue to maintain a dividend payment. The second benefit a dividend provides is the ability to easily recoup some of an initial investment. Those who invest only for capital gains might see their stock become worthless should a company go bankrupt. A dividend investor receives some of their initial investment back in the form of dividend payments.
Pay Attention to the Payout
A company’s payout ratio is an important stat that will indicate whether a dividend is sustainable for the long term. This number is the percentage of a company’s net income that gets paid out through dividends. A lower dividend payout ratio makes it more likely the company will be able to maintain its dividend into the future. A high payout ratio, especially one that’s more than 100% of net income, means a dividend cut is likely in the future unless the company is able to turn around its level of success.
Taxes on Dividends
Most dividends paid by US corporations are qualified dividends. This income receives special tax treatment from the government. It will be taxed at long-term capital gains rates that will not exceed 20% regardless of the income level a taxpayer reaches. This special tax rate makes dividend income more valuable than income from work.