One crucial element of your investing journey is understanding dividends and their role in building wealth. These payments can help investors grow their overall worth while providing opportunities to increase cash gains or reinvest in financial vehicles. With a few different ways to maximize the advantages of dividends, we’re taking a closer look at this monetary sum and how it can benefit investors.
A dividend is your portion of a company's profits distributed to shareholders as a reward for investing in that company. For example, if you own 100 shares of ABC Company, and they pay a $1 dividend per share, you'll receive $100 in dividends. It's like a small, regular paycheck coming from your investments.
Not all stocks pay dividends. However, those paying out dividends can offer features to help you build wealth over time.
When you buy a stock, you’re purchasing the chance to benefit from the growth in the underlying company. If the company performs well, the stock price likely rises. If it does poorly, the value may fall. However, dividend-producing investments offer another way for investors to make money. When dividends are included as part of a stock purchase, investors receive a regular, predictable stream of income, no matter what happens to the price of the stock over time.
Dividend-paying stocks tend to be issued by larger, high-quality companies, so they are typically less risky than smaller, unproven companies that don’t pay dividends. But dividends can protect you from risk in another way. The dividend itself can serve as a cushion in down markets, softening the impact of falling stock prices.
There are two ways to receive dividends from stocks and mutual funds. The simplest is to take your dividends as cash. If you choose this option, you’ll get a check every quarter for the amount you were paid in dividends. This can be reliable, predictable investment income.
However, you can also receive dividends as additional shares. This allows you to grow your wealth without investing any more cash. The shares you buy with dividend payments will pay dividends in future periods, so both your income stream and your total holdings will increase over time.
It’s important to remember that whether you receive dividends as cash or as shares of stock, you will have to pay taxes on them every year you receive them.
You can invest directly in individual dividend-paying stocks through dividend reinvestment programs or DRIPs. These programs are sponsored by the issuing company and generally charge no sales commissions. Some even give investors a small discount on their share purchases.
You can also invest in dividend-producing assets through mutual funds. These funds pool money from multiple investors to buy a diversified portfolio of stocks, bonds, or other securities. Income earned from these investments is redistributed to shareholders as dividends. The nature of these dividends may be taxable or tax-exempt depending on the fund. Some funds are focused exclusively or primarily on dividend-paying stocks. They are often called dividend income or equity income funds.
But dividends aren't exclusive to stocks or funds; they can also be found in whole life insurance policies.
Whole life insurance policies often pay dividends.1 The amount received depends on how much is invested in a policy, and it is typically paid out at policy anniversary once a year. You can receive whole life dividends as cash, you can use them to purchase additional insurance, or you can use them to pay a portion of your policy’s premiums, reducing the overall cost of your whole life insurance coverage.
How does it work? Say you own a policy worth $100,000. It pays out a 4% dividend to policyholders, which in your case is $4,000 a year. If you use that dividend to buy more insurance, your policy will be worth $104,000 the next year. Your dividend amount will be based on the new higher value the next year, so you’ll receive even more, $4,160 if your insurer keeps its dividend rate constant.
Reinvesting whole life dividends can be a terrific way to build wealth over time, but if you’d rather not, you can just take your dividend in cash or use it to offset some or all of your premiums going forward.
Not all dividend-producing investments are the same. As you choose investments for your portfolio, keep these factors in mind:
Company health: Financially sound companies and funds with a good, long-term track record are more likely to be able to continue to pay dividends, so you’ll want to focus on high-quality issuers. The same goes for insurance companies. You should thoroughly investigate any insurance companies with any below A ratings before investing.
Dividend history: Check the stock, fund, or policy history of dividend payments. Companies with a history of stable or growing dividends are often best.
Dividend yield: The dividend yield is the annual dividend income divided by the investment's current market price. A higher yield can mean more significant returns, but it may also signal higher risk.
Tax implications: Make sure you understand the tax implications of the dividends in your chosen investment. For example, dividends from stocks are typically taxable while life insurance policy dividends are often tax-exempt.
Dividend-paying investments, whether stocks, mutual funds or whole life policies, can be an important part of your long-term investment strategy, providing you with income, protection from risk, and another way to grow your portfolio. Talk to your financial professional to find out how these investments can work for you and which could best meet your unique needs and objectives.
1 Dividends, which provide an opportunity for cash value growth, are not guaranteed.
This article is provided for general informational purposes only. Neither New York Life Insurance Company, nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.
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