How to Get Dividend Income
Making money through dividend investing requires finding companies that have a good chance of increasing their dividend payments year after year, thereby causing more money to flow into your bank account. As the sales and profits of a company grow, so does dividend income.
Making money from dividend-paying stocks is one of the basic fundamentals of good investing, but new investors don't always fully understand dividends and how they work. They don't know how dividend stocks add a stream of income to their finances.
What Is a Dividend?
Companies fund dividend payments when they earn a profit. The board of directors, elected by the stockholders or owners, meets and listens to management's recommendations about how much of the profit should be reinvested in growth. A portion of the remaining profit is then paid out to shareholders as dividends.
Other concerns include how much profit should be used to pay down debt, and how much should be used to buy back stock.
Why Use Dividends for Income?
Your dividends can be reinvested, used to pay household bills, to send a child to college, to start a business, or even to pay for vacations or give to charity. The more shares you own of high-quality dividend stocks, the more money you can make. Dividend investors collect this specific type of investment over time.
Done correctly, the dividend investor's net worth and household income continue to expand and grow as time passes.
It would be possible to earn a substantial amount of money each year from dividends alone over 30, 40, 50 years or longer.
Anthony is 18 years old and he's just joined the workforce. He decides that he wants to start making money from dividend stocks so he begins investing. He chooses shares of high quality, blue chip companies that show healthy growth, strong balance sheets, and that have a solid history of increasing the dividends paid to stockholders over time.
He wants to avoid taxes, so he opens a Roth IRA to hold his dividend stocks, making sure to get the maximum tax advantage. Anthony can save and invest up to $6,000 annually, the contribution limit as of 2020, or $500 per month.
He'll never pay a single penny in taxes on the money he makes in the account as long as he follows the rules of Roth IRA investing. Contributions to the account are made with after-tax dollars and they can't be deducted from income, so withdrawals are tax-free after five years.
Anthony manages to grow his investments at 8% for the next 50 years. His portfolio has grown to a staggering $3,155,735.86 by the time he reaches 68 years old and decides to retire.
If he invests conservatively and chooses stocks with an average dividend yield of 3%, he would be collecting $94,672.08 in cash dividends each year. Remember, he doesn't have to pay a single penny in taxes on this income because he holds the stocks within his Roth IRA account.
Important Things to Consider
Successfully making money from dividend investing involves a handful of key considerations:
- The dividend yield a stock offers at the time of purchase
- The rate of growth in the company's profit, which can be used to project future dividend increases
- The health of the company's balance sheet, because investing in companies with tons of debt and declining sales presents a real risk no matter how large the dividend may appear
- The current dividend tax laws, such as the net investment income tax which went into effect in 2013, that's 3.8% of earnings if your modified adjusted gross income surpasses certain thresholds
You might consider a low-cost index fund that specializes in dividend-paying companies if you don't want to select individual dividend stocks but still want to try making money with dividend investing. As the name suggests, an index fund is an exchange-traded or mutual fund that tracks the market index.
One famous dividend index is the S&P 500 Dividend Aristocrats Index, which tracks large, high-quality blue-chip stocks in the S&P 500 that have successfully raised their dividend every year since 1995.
You can also investigate dividend-focused exchange traded funds (ETFs), such as the iShares Dow Jones Select Dividend Index or the Vanguard Dividend Appreciation ETF. Be sure to read the mutual fund prospectus for any potential investment to make sure you understand how the stocks held in the fund are chosen, and determine whether the risks are right for your financial situation.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.