Why Dividends Are Important To The Portfolio Of Every Investor

Let’s talk about dividends. Fixed income and old-school investors all love dividends. Dividends are a share of company’s profits that are paid out to shareholders. Many stocks, bonds, and mutual funds offer dividends to investors. Dividends provide a stable income stream that help to improve investment returns. While dividends are great for those investors, they are actually a good fit for regular investors as well. Here are a few of the key advantages of dividends:

Dividends are actual income.

What’s the only real return that investors receive when they buy a stock? The only actual return that is received is a dividend. One of the main advantages of dividends is that they provide investors with consistent realized income on a quarterly basis. Capital gains are not realized until you actually sell shares of a stock. Capital gains can disappear by a drop in stock price. Over the past 10 years, stock indices have been virtually flat. Without the existence of dividends, many investors would have found themselves earning no income over the lost decade.

Dividends have tax advantages.

Unlike income received from your employer and other investments, most dividend payments have special tax advantages. As long as you purchase a stock before the ex-dividend date and the investment is held for 60 days or longer, it is treated as a qualified dividend. Qualified dividends are taxed at an interest rate between 5% and 15%. High income wage earners have to pay 15% of their dividend payment via taxes. Lower income earners have a dividend tax rate of just 5%. These low tax rates allow shareholders to keep a large majority of their income.

Dividends allow you to purchase more shares.

Reinvesting your dividends is a quick and easy way to grow your portfolio. Dividends make it easier for investors to accumulate more shares. Investors always have the option of reinvesting all or a portion of their dividend proceeds back into their original stock investment. Most brokers and DRIP’s (Dividend Reinvestment Plan) offer free reinvestment options to all customers.

So, where should you look for dividends?

Best Places To Look For Dividends

If you are looking for high dividend yields, start with stocks. Look at telecommunication companies, REIT’s, and utility companies. All of these industries are known to have extremely high payouts compared to other sectors. For example, telecommunication companies AT&T and Verizon are both paying investors over 6%. REIT’s like Annaly Capital and Hatteras Financial have double digit yields. Utility stocks Duke Energy and Consolidated Edison are each paying over 5% to investors.

Another way to get access to dividends is by investing in dividend growth funds. For example, the Vanguard Dividend Growth Fund primarily invests in large cap dividend paying stocks. Funds like this boast low expense ratios and consistent, modest dividend yields. Bond funds are also good investments for monthly dividend payments to all bondholders.

Are dividends an important consideration for you in your investment portfolio? What are your thoughts on allocation a portion of your portfolio for dividend paying securities.

(Photo credit: Naval History And Heritage Command)

  • Patrick

    Good article. I’m about to make another purchase in the market and am still trying to figure out some investments. Dividend and utilities ETFs have been at the top of my list for a while. I do like the idea of reinvestment (it’s almost a mini “dollar cost averaging” plan in and of itself). Once enough shares are owned, then instead of reinvesting those dividends, I would consider using them as a passive income source.

    • http://buylikebuffett.com/ Mark Riddix

      Thanks Patrick.

  • http://ownthedollar.com Hank

    Dividends are important to every investors by studies have shown that dividends account for approximately 40% of total market returns. So, if you are expecting a return on your investments of 8-10%. 4% will come from dividends being reinvested. That is assuming you have dividend stocks in your portfolio.

    • http://buylikebuffett.com/ Mark Riddix

      There are some great dividend yields in the market right now Hank.

  • Phil Gorian

    Dividends are particularly important in slow growth cycles. Just be careful about high dividend yields, they can be cut.

    • Mark Riddix

      Great point. I like to compare dividend yields to their historical averages. If they are too high then I figure that they are likely to be cut.

      • Phil Gorian

        Thank you. Having the dividend cut out from under you on a stock you just bought for the dividend can be a tough lesson to learn the hard way. As you mentioned, you really need to do your research on a corporation’s dividend cutting history before you buy, especially in these low rate environments. Companies with a long history of increasing their dividends coupled with a favorable market price are usually always your best bet. These days, you really have to be careful as we have seen many traditional blue chip dividend paying companies cut their dividends, with some completely eliminating them for now.

        • http://buylikebuffett.com/ Mark Riddix

          Very true. That’s why it’s important for a company to have a significant amount of cash on hand.

  • http://www.forestcotton.blogspot.com/ Jim

    Its always a good idea to keep in mind that is dividends can greatly increase returns over time. But do not get to much into stocks that have really high yields. Generally speaking thats a warning sign that the company could be having some serious problems.

  • Daren

    A friend of mine says that dividends are worthless because when they are paid, the price of the stock goes down in corresponding fashion leaving you with the same amount of money as before the dividend was paid. When you factor in taxes paid on the dividend income, you are actually losing money. I am having trouble finding an argument to counter his logic.

  • http://www.dividendinvestor.com/ Richard Gere

    Dividends are very important part of investing. They offer more than income. Investor can gain more profit by reinvesting them but at the present time of low–yield people want to generate safe income, so they are continuously turning to dividend paying stocks to make money.