If you’re interested in tax-efficient income, dividend stocks are an excellent choice. Many investors find them compelling. After all, buying high dividend stocks in an extended low-interest-rate environment puts them at ease. However, like all investments, they have their share of potential risks.
Without question, dividend stocks make great investments. Not only do they provide income, but they also have strong potential for capital gains. To determine if this is right for you, consider the biggest advantages and disadvantages of these stocks.
In this article
The Rundown on Dividend Stocks
Fast and Protected Money
The best reason for investing in dividend stocks is they pay real cash in real-time. With a lot of other investments, it takes time to see any money. After all, the product must first prove its worthiness in the marketplace. Then you wait even longer in anticipation of the product company’s stock prices increasing. In comparison, you’ll receive money on dividend stocks every three months without fail.
To increase your earnings, you can invest small amounts into high-yielding stocks. Some of the best industries are electric utility, telephone, pharmaceutical, oil, and even banking institutions. Take your time to look for stocks with a history of providing great yields.
The government protects the money you put into a traditional savings account. Unfortunately, there’s nothing in the current laws that states a company can’t reduce its dividends or eliminate them. So, if profits decrease, there’s a good chance the dividends will too. This means that even when choosing dividend stocks carefully, you don’t have the same type of government insurance as with a conventional savings account.
More often than not, companies increase their dividends. Take a top oil company as an example. At the close of one year, it paid a quarterly dividend of $0.68. However, just four years later, it raised the amount to $1. Yes, companies can reduce dividends, but for the best companies with solid balance sheets, this does not happen very often.
Many companies pay generous dividends, including the old-line and utility industry. However, the majority of fast-growing small-cap stocks, including those offered by high-tech companies, don’t pay dividends at all. So, if you’re not careful, you could end up investing in a company’s stock without getting any income in return.
Potential for Returns Comparable to the Market
Historically, certain dividend stocks paid returns over time that compared to the market as a whole. Even more exciting, they’ve done this without any significant volatility. Overall, that means that dividend stocks are a much safer option compared to other investments. They even do quite well during a market turndown. It has been proven time and again that dividend-paying stocks have less volatile returns than non-dividend payers.
Even as a safe option with great potential for returns, it’s hard to consider dividend stocks better than bonds. Just as with stocks, bonds also come with risks, although low. However, when comparing dividend stocks to bonds, there’s more risk with the stocks. This is especially true when it comes to short-term bonds of exceptional quality. A bond’s interest payment is set and can only be changed if the company defaults. However, as mentioned previously, a company can reduce its dividends at any time and for any reason.
When compared to bonds, dividend stocks are more tax efficient. They’re also more tax-efficient than ordinary income. The reason, is they’re taxed at a much lower rate. This is why individuals in lower tax brackets don’t pay federal income taxes on the dividend stocks they purchase. Even those in a higher tax bracket won’t pay more than 35 per cent. However, dividend stocks are currently taxed at just 15 per cent.
The only possible downfall is that there’s no guarantee that the tax rate will remain where it is or what it’s capped at.
How Dividends Can Change Your Retirement Picture
Dividends provide a stable source of income in retirement and this is key to never run out of money. If your retirement income is greater than your retirement expenses, you are all set. You can rest easy at that point knowing that you won’t run out of money in retirement. It is imperative that you create a retirement plan to see if your income will cover your expenses. Use a good retirement forecast tool such as WealthTrace or Fidelity’s Retirement Calculator to see if you are forecasted to have enough income in retirement.
A Financial Advisor Can Help With Your Investments
If you want to invest in high dividend stocks or perhaps mutual funds or ETFs, you’ll probably need some professional guidance. This is where the services of a professional tax advisor are incredibly valuable.
You want to make sure you buy the right stocks today and ultimately get the best yield possible. Especially with so much debate about taxes in Washington, you need someone who can provide the right information, so you make an excellent decision. Hiring a financial advisor is one of the best things you can do to build and strengthen your investment portfolio, especially dividend stocks.