-- Investing in stocks that pay dividends is a time-honored strategy, and for good reason. It’s a great way to capture regular income in the form of dividend checks while benefiting from share-price appreciation.
The case for dividend stocks to power your portfolio is convincing. A study by Morgan Stanley’s Adam Parker showed that from 1930 through 2012, dividends accounted for 41.8 percent of total return of the S&P 500.
Dividends are payments companies send to shareholders. These payments come from net profits, and are often made quarterly, but some companies pay them monthly or annually.
Depending on the circumstances, you may be able to receive your dividends either as cash or as reinvestments in additional shares. Both methods have pluses.
If you’re looking for income from your investments, cash dividends are highly desirable. This can be particularly helpful in a bear market, because you don’t have to liquidate investments at a bad time.
Also, dividends are relatively tax-friendly for investment income. For most people, the tax rate for most dividends is 15 percent.
Investors typically have the option of getting dividends in the form of shares, which can propel highly beneficial compounding of your initial investment. As you will have to pay tax on dividends, it’s important to keep track of the shares you acquire this way so you don’t inadvertently pay double tax on them. For example, suppose you buy $1,000 of a stock and then receive $100 in dividends that you reinvest in the same stock. This $100 gain is taxable in the year that you received it. If you don’t remember this tax payment and sell your $1,100 in stock the following year, you might mistakenly pay tax again on the $100 gain. Brokerages account for this. If you’re handling these issues yourself, you must pay close attention to avoid this common error.
Though much has been written and said about owning shares of dividend-paying companies, many investors are unaware of nuances that can make a significant difference in the effectiveness of their dividend strategy. The key to keep in mind is the quality of the dividends that a given company may pay. Here are some points to consider:
Companies that pay dividends regularly and reliably tend to be large and mature. But there are also many small and mid-size companies that have histories of good dividend payments –- though these histories don’t tend to be as long as those of larger companies. So it’s possible to put together a well-balanced portfolio of different size companies –- in different industries -– that are good dividend payers.
Pursuing dividend companies is often a good idea. But investors should always look for quality dividends as a sign of companies that are desirable to own for many other reasons. By purchasing quality dividend companies, you can position for growth in value through long-term appreciation while reaping the incremental rewards of dividend income or additional shares along the way.
Any opinions expressed in this column are solely those of the authors.
Jamie Cornehlsen and Ted Schwartz are advisors with Capstone Investment Financial Group in Colorado Springs, Colo. Cornehlsen is also president of Dunn Warren Investment Advisors in Greenwood Village, Colo. A Certified Financial Planner®, Schwartz advises individuals and endowments. He holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at firstname.lastname@example.org. Cornehlsen, a Chartered Financial Analyst®, advises business owners and employees on retirement plans. He holds a B.A. from the University of Colorado and an M.B.A. from the William E. Simon School of Business at the University of Rochester. He can be reached at email@example.com.