The Basics of Income Investing Explained
When it comes to quality in the investment world, one thing that will never go out of style is dividends.
A dividend is a distribution of a portion of a company’s earnings — paid regularly (typically quarterly) to a company’s shareholders.
It can be issued as a cash payment or as shares of a stock or other property.
And for savvy income earners, dividends are one of the smartest and easiest ways to secure to the extra cash needed to pad your retirement or enjoy life’s luxuries.
Dividends originally gained widespread popularity as a way to generate income for widows to live comfortably after their husbands died.
Before the 1960s, the conventional (but stupid) wisdom was that women were incapable of supporting themselves and income portfolios were referred to as “widows’ portfolios.”
All local community banks had trust departments with veteran bank officials whose job it was to take the life insurance money from widows and put together a carefully crafted collection of stocks, bonds and other assets that would generate enough monthly income for her to pay the bills, keep the house and raise the children.
The goal was not to get rich. The goal was to make sure the family’s income needs were taken care of.
Retirees soon realized that income portfolios based on dividends were an ideal way to enjoy a secure retirement.
Sadly, income investing is considered too boring and too unproductive. The process of building an income-producing portfolio has become a long-lost practice.
Not because interest rates are much lower but because income investing has lost its appeal thanks to the great bull market, which has spoiled investors into believing concepts like risk management and dividends aren’t important anymore.
The reality is, however, that owning a basket of high-quality dividend stocks is the cornerstone of a successful, money-generating portfolio.
Here are three reasons why.
3 Reasons to Love Dividend Stocks
Why should you consider dividend-paying stocks over traditional fixed-income investments like bonds and CDs?
Well, for starters…
Reason #1: Stocks pay more! The dividend yield on the S&P 500 is just under 2%, but you’d have to go out to five years (or longer) with Treasury bonds to get a similar yield.
Of course, shorter-term bonds would pay even less, and after three interest rate hikes by the Federal Reserve, long-term bonds are a dangerous proposition.
Reason #2: Half the tax! The rate at which qualified dividends are taxed depends upon the income of the recipient.
For those in the 10–15% income bracket, there is no tax whatsoever on a qualified dividend. Yup — zilch, zip, nada.
For those in the 25–35% tax bracket, qualified dividends are taxed at a 15% rate.
For those in the 39.6% tax bracket, dividends are taxed at a 20% rate.
I don’t care how you slice it — 0%, 15% and 20% tax rates on dividends beat the heck out of a 39.6% tax rate on interest income. And that is why dividend-paying stocks should be the foundation of any income portfolio.
Reason #3: Dividends grow. The S&P 500 may pay a 2% dividend today but that payout is going to increase over time. Over the last seven years, companies in the S&P 500 increased their dividends by an average of almost 7%.
Choosing the Right Companies
There are thousands of companies on the market that pay out dividends. It’s one of the safest and most reliable ways to grow your income.
But not all companies are the same. There are two very important criteria I look for when it comes to the companies paying out the best dividends:
- A dividend yield of 2% or higher.
- A low dividend payout ratio (click here for full explanation)
If you use these factors to determine the health of a company, you’ll also help ensure the dividend stocks you add to your portfolio will be the best of the bunch.
Then just sit back and watch the money roll in.
Here’s to growing your wealth,
Chief Income Expert, Mike Burnick’s Wealth Watch