A dividend stock is one that pays out regular (generally quarterly) dividends to shareholders, which can be taken as cash or reinvested. The dividend represents a certain dollar (or cents) amount paid out per share. These are typically stocks from steady, high-quality companies with a consistent track record for growth such that they can consistently offer dividends to their investors.6
Investors who reinvest their dividends have the potential to accumulate wealth more quickly, as reinvested dividends go toward buying more shares of the same stock. If stock prices rise over time, the more shares held means a greater total return.7
Because dividend stocks provide additional growth opportunity through reinvestment, they are quite popular among investors and account for a large part of the stock market. According to a one study, from 1930 to 2012, dividends represented almost 42 percent of the total return of the S&P 500 index. Only 6 percent of dividend-paying firms lost money in at least one year between 1972 and 2011.8
When an investor retires, he or she can start using dividend payouts as a supplemental form of retirement income without having to sell shares in the stock. Because dividends are prone to increase over time,9 they may also offer a long-term inflation hedge.
Another benefit is that qualified dividends are taxed at the current capital gains rate of 15 percent for individuals who earn less than $415,050 a year (20 percent for those who make above that amount; zero for individuals who earn less than $37,650 a year).10
Note, however, that as with any investment, dividend stocks are subject to risk, including the complete loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Also, dividend payouts can be reduced or eliminated altogether,11 and are paid at the discretion of the board of directors and are therefore not guaranteed.
It’s important to consider any investment within the context of your own goals, risk tolerance, investment timeline and the composition of your overall portfolio. You should speak with a qualified financial advisor and tax advisor before making any decisions about your personal situation.
6 Miles D. White. CNBC. Oct. 24, 2016. “Op-Ed: She bought just 3 shares and became a multimillionaire.” http://www.cnbc.com/2016/10/24/dividends-a-get-rich-slowly-scheme-for-everyone.html. Accessed Nov. 16, 2016.
9 Tom Sightings. U.S. News & World Report. April 8, 2014. “The Pros and Cons of Dividend Stocks.” http://money.usnews.com/money/blogs/on-retirement/2014/04/08/the-pros-and-cons-of-dividend-stocks. Accessed Nov. 22, 2016.
10 Rande Spiegelman. Charles Schwab. Jan. 12, 2016. “Taxes: What’s New for 2016?” http://www.schwab.com/public/schwab/nn/articles/Taxes-Whats-New. Accessed Nov. 16, 2016.
11 Tom Sightings. U.S. News & World Report. April 8, 2014. “The Pros and Cons of Dividend Stocks.” http://money.usnews.com/money/blogs/on-retirement/2014/04/08/the-pros-and-cons-of-dividend-stocks. Accessed Nov. 22, 2016.