Dividend Stocks Explained
Dividend stocks are proportionate circulation of additional shares of an organization’s stock to proprietors of the common stock. Whenever a company declares a stock dividend, stockholders will receive additional shares of the stock. There are various reasons for a company to opt for stock dividend, it may be insufficient cash on hand or the desire of company to lower down the price of stock on per-share basis in order to bring on more trading options and to increase liquidity.
Benefits of Dividend Stocks
Apart from the immediate cash flow from stock investments, there are other advantages of dividend stocks which includes opportunities of reinvestment for special tax rates and larger payouts. Here are some benefits of investing in dividing stocks.
Relative Stability
Generally, a company with a regular stream of earnings will pay a consistent dividend. Most of the companies which have a long dividend history are reliable. In comparison to market, top dividend stocks are less volatile and are in high demand.
Dividend Reinvestment
You can reinvest your cash dividends into additional stock shares, rather than getting cash distribution. By the passing time, your investment will grow much faster as these reinvested dividends will result in compounding interest.
Source of Income
Dividend stock is also a great means of income generation for investors. You can also consider it a great benefit because you can earn passive income when the stock market goes nowhere and your wait for the increased price of your stock.
Dividend Tax Rate
In most of the dividend stocks, a special tax rate is imposed. This special dividend tax rate is known as the qualified dividend rate. As per this tax rate, you will not have to pay your ordinary income tax rate on your dividend income. A special rate of either 0 percent, 15 percent or 20 percent is imposed, according to your tax rate.
Limitations of Dividend Stocks
Although dividend stocks are steady means of income, there are some limitations of dividend stocks too. Following are the limitations of dividend stocks:
Dividend Cut Risk
The dividend amount that an organization pays with respect to its overall net income is known as its dividend payout ratio. In spite of the fact that a high payout ratio may appear to be something to be worthy, if an organization's dividend per share is excessively high, it may be unsustainable going ahead. On the other hand, if that dividend gets cut in the coming days, the price of stock could suffer immensely.
Sometimes, a dividend appears to be high because an organization's stock price has already fallen down significantly, because of the fall in income. An organization with falling income does not impart certainty for dividend payments.
Double Taxation
There is a burden of double taxation on dividends. Firstly, the government imposes tax on the income which is earned by the company at the company’s tax rate. Secondly, another tax is needed to be paid by the investor during return filing. The problem of double taxation can be avoided if the company starts reinvesting its profits rather than distributing them to the shareholders.
Low growth and Low Income
The growth of dividend stocks is low because growth investors tend to invest in those stocks which are more rewarding and risky. Investors can not generate more income from dividend stocks. In order to generate more income, they will have to purchase bonds.
Ways to Buy Dividend Stocks
Purchasing dividend stocks are same as purchasing other stocks. In order to buy these stocks, you need to open a brokerage account with an online broker of your choice. After that, you will have to research all those companies that pay dividends and have a reliable payment history. Nowadays, many online stock brokers offer tools like screeners through which you can easily find those stocks which pay high dividends.
The Bottom Line
For many investors, dividend-paying stocks are considered as an income generating means for their retirement years. Whether its dividend stock investments or any other sort of stock investments, one should always do his own homework, research on several stocks, their pros and cons and choose those investments which are suit you, for your investment style, risk tolerance, time horizon and financial objectives. You can get a variety of resource items in online and in print in order to make a well-informed investment decision.
It’s always recommended to consult with a financial expert and tax specialist to determine the best course of action for your overall trading strategy.
