Famed investor Warren Buffett once said, “If you don’t find a way to make money while you sleep, you will work until you die.”
Dividend stock investing is a exactly that kind of of “make money while you sleep strategy.” It provides investors with passive income and can be a great means for retirees to stay afloat.
Dividends are payments that companies make to shareholders. These payments are taken from the earnings of the company. Company managers can choose to retain and reinvest earnings or pay some or all of it to investors.
Growth companies tend to retain all the earnings of the company. Managers typically feel they can get a better return for investors by reinvesting all earnings into the company.
When growth slows down for companies, managers often choose to pay part of the earnings to shareholders. This payment is in the form of a dividend.
Besides their income-producing abilities, dividends also serve as protection when stocks enter a period of consolidation. Companies may choose to reduce dividends for extended periods. However, many solid companies choose instead to forego raising the dividend in slow times, rather than cutting it.
Dividend investing can boost the returns of retirement accounts. In many cases, too, dividend payments are tax-deferred. Investors should consult tax professionals if unsure of the status of their retirement accounts taxability.
Investors self-managing their retirement accounts, such as those with IRAs, will need to decide whether to reinvest the dividends into more shares of a dividend-paying stock, mutual fund or ETF.
For accounts managed by others, like a 401(k), there may not be a choice. Check with your plan administrator.
Reinvesting dividend is powerful way to accumulate the assets needed to retire. As most investors won’t touch their retirement accounts until later in life, there is very little reason not to take advantage of reinvesting dividends.
Don’t focus only on the yields
Most investors seek the highest-yielding investments possible. It’s no different with dividend stocks. However, placing too much emphasis on looking for yield can be counterproductive.
Well-managed companies have a history of paying dividends that are in-line with their industries. These companies may increase their dividends steadily, which is usually a good sign.
Conversely, companies looking to use accounting tricks may increase their dividends to entice unsuspecting investors. Like anything else, if it seems to good to be true, it probably is. Paying out high yields on dividends for poorly run firms is usually unsustainable.
Evaluating dividend stocks should be approached in the same way as growth stocks. Investors should analyze the financial statements to ensure the company is well-managed.
Investors should search the history of the company for discrepancies or inconsistencies with their accounting practices. Dividend companies are seldom new companies. Most companies that pay dividends will have a history that can easily be found online.
Many companies offer a dividend reinvestment plan (DRIP). With this program, investors buy shares directly from the company. All dividends are reinvested automatically by the company.
The reinvestment is commission-free. However, with no-commission trades offered by brokerage firms DRIPs are not as popular as they used to be.