On Friday, I sat at lunch with some friends talking about life, weekend plans, and personal finance. I’m a dork I know, but I found myself explaining what are dividends and dividend investing. So let me take a shot at this since I talk about them ALL the time.
Let’s start with what are dividends. Dividends are a portion of a company’s profits that are paid regularly to the company’s shareholders. The amount of profits shared among shareholders is a percentage of the stock price called “yield”. This is shared sometimes annually, quarterly or monthly to the shareholders depending on the company.
Dividends are popular because not only do shareholders of a company’s stock see the price move. They receive dividends just for owning the stock. It’s like a small bonus.
For example: Apple (AAPL) stock price is currently $100. Apple has an annual dividend yield of 2.27%. Shareholders will receive $2.27 throughout the year just for holding onto the stock. The neat part is shareholders will receive income from their investment without selling.
Why do stocks produce dividends?
First, not all stocks produce dividends. Stocks like Google and Amazon don’t produce dividends. Every company decides for themselves whether they want to or not.
Stocks like Google and Amazon don’t wish to produce dividends because they want to focus all extra capital for research and development. Typically younger companies like this don’t pay dividends. However if you look at Coca-Cola, while they do innovate, their extra cash is distributed as dividends because they found it’s better put towards dividends to attract more investors. Dividends are very attractive to investors because of compounding.
Let’s Talk Compounding!
The idea is that dividends will compound increasing your investment. Let’s say you invest in 50 shares of stock ABC at $100 a share with a 3% dividend yield, you’ll annually earn $150 per year in dividends. However if the stock increases its dividend 5% (not stock price value, but dividend yield), your $5,000 investment in 20 years will be worth $13,143. That’s a 162.85% gain! Here’s a great dividend reinvestment calculator.
That’s if the stock stayed the same price at $100, but typically the market increases annually at 7%. So both the stock price and dividend will increase. Cool right?
Dividend Investing is the idea of investing in only stocks that produce dividends. The purpose being of living off the dividends produced by the stocks you own opposed to selling your stocks for money. It essentially creates passive income.
Let’s say you plan to live roughly till your 92, and you wantto have $60,000 per year for retirement. If you retire at 65 you would need to have $1,620,000 (before taxes) saved up to spend $60k every year. Yet, by 92 you will have run out of money, totally broke, dirt poor.
However dividend investors use dividend yield to create passive income for retirement. In the same situation, a dividend investor would save a larger amount upfront, $2,000,000 in a portfolio of dividend stocks at a 3% dividend yield. That 3% yield will create $60,000 (before taxes) per year. If you never touch your principal (that $2,000,000) you’ll be able to keep receiving dividends every year, forever. So even if you live to 126 (oldest person in the world), you can rely on that $60,000 every yearsince people seem to keep living longer and longer. I personally plan to live to 182.
Dividend Investing is relying on a reoccurring stream of income that never runs out opposed to a stash of cash that will eventually run out. If you haven’t figured it out, I’m a dividend investor.
Fun Fact: All five of Warrant Buffett (one of the greatest investors of all time) largest stock holdings pay dividends. These are Wells Fargo, Coca-Cola, American Express, IBM and Wal-Mart. He lives on the buy and hold strategy. He invests in good companies that pay dividends and sits back and receives a paycheck. Sounds like a dividend investor to me.
I’m constantly wordsmithing on how to explain what are dividends and dividend investing to people. How’d I do? Any tips on explaining it better?
Wallet Squirrel is a personal finance blog by best friends on how money works, building side-hustles, and the benefits of cleverly investing the profits. Featured on MSN Money, AOL Finance, and more!
FAQs
Understanding Dividends
How does dividend investing work? ›
Stock dividends are payments a company makes from its overall profits to shareholders as a reward for their investment. Dividends are most commonly paid to shareholders as cash dividends but are occasionally paid out as additional shares of stock.
What are examples of dividend investing? ›
For example, if a company issues a stock dividend of 5%, it will pay 0.05 shares for every share owned by a shareholder. The owner of 100 shares would get five additional shares.
What is difference between dividend and dividend? ›
While dividend yield refers to the percentage of the current stock price of a company paid out as dividend over a year, dividend rate is the amount of money that company pays to its shareholders as dividends on per-share basis.
How to make $1,000 in dividends every month? ›
To have a perfect portfolio to generate $1000/month in dividends, one should have at least 30 stocks in at least 10 different sectors. No stock should not be more than 3.33% of your portfolio. If each stock generates around $400 in dividend income per year, 30 of each will generate $12,000 a year or $1000/month.
How much money do I need to invest to make 3000 a month? ›
Imagine you wish to amass $3000 monthly from your investments, amounting to $36,000 annually. If you park your funds in a savings account offering a 2% annual interest rate, you'd need to inject roughly $1.8 million into the account. This substantial amount is due to savings accounts' relatively low return rate.
What is the downside of dividend investing? ›
Despite their storied histories, they cut their dividends. 9 In other words, dividends are not guaranteed and are subject to macroeconomic and company-specific risks. Another downside to dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders.
How to make money off dividends? ›
In order to collect dividends on a stock, you simply need to own shares in the company through a brokerage account or a retirement plan such as an IRA. When the dividends are paid, the cash will automatically be deposited into your account.
How much money do I need to invest to make $1000 a month? ›
Invest in Dividend Stocks
A stock portfolio focused on dividends can generate $1,000 per month or more in perpetual passive income, Mircea Iosif wrote on Medium. “For example, at a 4% dividend yield, you would need a portfolio worth $300,000.
How much money do I need to invest to make $4000 a month? ›
Making $4,000 a month based on your investments alone is not a small feat. For example, if you have an investment or combination of investments with a 9.5% yield, you would have to invest $500,000 or more potentially. This is a high amount, but could almost guarantee you a $4,000 monthly dividend income.
That usually comes in quarterly, semi-annual or annual payments. Shares of public companies that split profits with shareholders by paying cash dividends yield between 2% and 6% a year. With that in mind, putting $250,000 into low-yielding dividend stocks or $83,333 into high-yielding shares will get your $500 a month.
Are dividends taxed? ›
Taxable dividend income above the dividend allowance and falling within the basic-rate band is taxed at the dividend ordinary rate. Taxable dividend income above the dividend allowance and falling within the higher-rate band is taxed at the dividend upper rate.
Is dividend better than stocks? ›
The relationship between dividends and market value
Dividend-paying stocks, on average, tend to be less volatile than non-dividend-paying stocks. A dividend stream, especially when reinvested to take advantage of the power of compounding, can help build wealth over time. However, dividends do have a cost.
Does Amazon pay dividends? ›
Amazon's valuation doesn't support a dividend
As a stock, Amazon is different from Meta, Alphabet, Apple, and Microsoft, the Magnificent Seven stocks that pay a dividend.
How do you make money with dividends? ›
In order to collect dividends on a stock, you simply need to own shares in the company through a brokerage account or a retirement plan such as an IRA. When the dividends are paid, the cash will automatically be deposited into your account.
Is it worth investing in dividends? ›
First, they provide a regular income stream, which can be especially attractive to income-focused investors such as retirees. Second, dividends are often seen as a sign of a company's financial health and stability, as they indicate that it's generating enough profits to distribute at least some to shareholders.
How to make 5k a month in dividends? ›
To generate $5,000 per month in dividends, you would need a portfolio value of approximately $1 million invested in stocks with an average dividend yield of 5%. For example, Johnson & Johnson stock currently yields 2.7% annually. $1 million invested would generate about $27,000 per year or $2,250 per month.
