Key Takeaways
- Dividend stocks pay out dividends on a regular basis, creating a regular, dependable income stream for stockholders.
- Dividend-paying companies are often large, secure businesses that can add stability to your investment portfolio, especially during market downturns.
While dividend stocks may be known as the tortoises of the investing world with their slow and steady gains, they reliably pay out regular income in up or down markets. Below, the MarketWatch Guides team explains how dividend stocks work, why some investors love them and how they can add equilibrium to your portfolio.
What Are Dividend Stocks?
Dividend stocks are equity shares of companies that regularly pay out a portion of their profits, known as dividends, to shareholders. These payments are typically made in cash on a quarterly or annual basis, though some companies issue additional shares of stock instead.
Dividends are most commonly paid by larger, more established companies whose stocks may experience slower growth. By offering dividends, these companies aim to attract investors seeking steady income. In contrast, younger startups or smaller companies, which tend to pursue rapid growth and often produce higher returns, usually reinvest their profits in the company and don’t pay out dividends.
How Do Dividend Stocks Work?
Dividend stocks typically pay regular dividends on a quarterly or yearly basis. The dividend yield — how much a company pays in dividends relative to its stock price — is a key measure for evaluating dividend income, and it can vary widely between companies. A high dividend yield may suggest that a company is financially healthy and generating strong cash flow, but it may also indicate limited reinvestment in growth projects, which could hinder a company’s future opportunities.
Before dividends can be paid, they have to be approved by the company’s board of directors. The company will announce that it’s paying a dividend, which is referred to as the announcement date or declaration date, along with when the dividend will be paid. Shareholders have to have purchased the stock before the ex-dividend date, which is the date when dividend eligibility expires. The payment date is the date when the dividend will be deposited or reinvested in your investing account.
How Dividends Are Taxed
Dividends are taxable income, and they can be taxed in two ways:
- Qualified dividends: Most dividends are considered qualified dividends, meaning they’re taxed at a lower, long-term capital-gains tax rate of 0%, 15% or 20%, depending on your income and filing status.
- Ordinary dividends: Dividends from real estate investment trusts, master limited partnerships and many foreign stocks are often classified as ordinary dividends, meaning they’re taxed at your regular income-tax rate.
If your dividend stocks are held in a taxable account, as opposed to a retirement or other tax-advantaged account, you’ll be taxed on your dividends even if you reinvest them.
Pros and Cons of Dividend Stocks
Here are some of the pros and cons of dividend stocks:
Pros
Tax advantages: Dividend payouts can provide tax advantages over other assets, such as bonds.
Portfolio growth: With dividend reinvestment, you can purchase additional shares and grow your portfolio more over time.
Stability: Stocks that pay steady dividends are often well established and less volatile, offering stability for your portfolio.
Cons
Impacts on appreciation: Paying out dividends affects how much revenue a company can invest, which can affect the stock’s growth over time. Stock prices typically fall when dividends are paid, reflecting the decrease in the company’s assets.
Risk of dividend cuts: There’s no guarantee a stock will keep paying dividends. If a company has financial difficulties or changes its business strategy, it may discontinue dividend payouts.
Types of Dividend Stocks
Here are some of the different types of dividend stocks:
Blue-Chip Stocks
Blue-chip stocks are typically large, well-established companies with excellent reputations and a long history of solid performance. Albeit not always, these companies often pay out dividends regardless of market conditions.
Dividend Aristocrats and Kings
These are large, publicly traded companies known for increasing their dividends over time. Aristocrats have increased their dividends for 25 consecutive years or more, while kings have increased their dividends for 50 years or more.
Real Estate Investment Trusts and Master Limited Partnerships
Real estate investment trusts and master limited partnerships are both legally required to distribute the majority of their income to their shareholders. REITs invest in real estate, and MLPs operate in energy and natural resources.
Utilities and Consumer Staples
Utilities and consumer staples companies produce gas, power, food, beverages and household goods. Since their products are normally always in demand, companies in this sector typically generate stable profits, which means consistent dividends.
Why Do Investors Choose Dividend Stocks?
Investors choose dividend stocks for varied reasons, such as:
Retirement Investing
Many people find that dividend stocks are ideal for retirement investing because they provide steady streams of income. Some investors who are near or already in retirement rely on this predictable cash flow to supplement other income sources, such as pensions or Social Security retirement benefits.
Compounding Returns
For investors looking to compound their returns, dividend reinvestment plans allow investors to automatically invest their dividend payouts into additional shares. Over time, DRIPs can accelerate portfolio growth through the power of compounding.
More Stability
Holding dividend stocks also serves as a defensive play in down markets. Because many dividend-paying companies operate in stable, essential industries — such as utilities and health care — they tend to be less volatile and more resilient during market downturns.
How To Start Investing in Dividend Stocks
To start investing in dividend stocks, you can use your brokerage’s screener tools to find individual stocks. If you’re investing in individual stocks, research has suggested diversifying your portfolio by purchasing stocks from about 30 to 50 companies.
Another way to create a diversified portfolio of dividend stocks is investing in dividend exchange-traded funds or mutual funds. There are many funds that are made up of dozens or hundreds of dividend stocks and are designed to produce high dividend yields for investors.
Frequently Asked Questions About Dividend Stocks
Whether it’s a good idea to buy dividend stocks depends on your investing goals. Dividend stocks can provide steady income streams, and they tend to be stable, less volatile stocks. However, they may not provide as much growth as stocks from younger, smaller companies.
To make $1,000 a month in dividends, you’d need to invest between $200,000 and $480,000, assuming the stocks you’re invested in have 2.5% to 6% dividend yields. If a dividend yield is 2.5% per year, you’d need to invest $480,000, which would yield $12,000 per year, or $1,000 per month.
Yes, Coca-Cola is considered a dividend stock. The company has paid its shareholders regular dividends for decades, and it’s been reliably profitable regardless of market conditions. Coca-Cola is known as a Dividend King — a member of a select group of companies that have paid out steadily increasing dividends over the past 50 years.
*Data accurate at time of publication
*The content provided in this article is for informational purposes only and should not be construed as financial, investment or tax advice. You should consult a licensed financial adviser or tax professional before making any investment decisions. All investments carry risks, including the possible loss of principal. Past performance is not indicative of future results.