It’s no secret that I’m a big believer in income investing. Folks who know my philosophy know that dividend-paying stocks rank high on my list of portfolio assets to consider. And why not? The benefits of dividend-paying stocks are far reaching.
Are you missing out on the benefits of dividend-paying stocks?
Here are the top six reasons I own dividend-paying stocks.
The ability to control what you can
So many things in life are beyond our control. When it comes to investing, this maxim rings especially true. There’s no surefire way to predict — much less control — market highs and lows and individual stock behaviors.
By investing in dividend-paying stocks, we can implement at least some level of control over our investments. This control comes largely in the form of stock dividends or the cash flow we receive from companies that pay perennial dividends. Of course, dividend payouts can change in a heartbeat if companies run into trouble. However, many companies place an enormous amount of importance on maintaining and even increasing their dividend payout over time. In fact, there are many companies — like Church & Dwight and General Mills — that have paid dividends for more than 100 years without interruption. In a world full of uncertainty, finding companies with historically steady quarterly payouts let us sleep better at night.
Targeting the Sweet Spot
The goal of every solid investment portfolio is to maximize returns. Sounds logical, right? But how do you do that? I’m glad you asked!
Remember that your total return equals the growth of your investment’s share price plus any income that your investments realize. Most investors hone in on just the growth piece of the equation and give short shrift to the income piece. But income is a crucial component to this equation, too. As long as a dividend paying company doesn’t hit a disastrous speed bump, chances are that they will continue to pay a measured level of income and could show varying degrees of price growth, depending on the sector and company.
Dividends don’t lie
Consistent dividend payment can be a sign that a company is in solid financial health. There’s wisdom behind that famous investment quote: “Dividends don’t lie.”
Consider this: A company can re-categorize expenses, adjust to complicated tax changes, and manufacture ways of favorably disclosing financial transactions. All of these practices lead to a “muddy” earnings report. But when a company pays a dividend, it’s a testament that the company has cash in the bank to make the payment. Companies with this cash flow paying ability typically have strong and solid balance sheets. They also tend to have a diversified business model that generates steady and growing profits. This allows them to provide you with income along with the potential for share growth.
And remember, once you’ve received your dividend check, there’s no arguing with cash in the bank.
Bond yields are currently low
Investors buy bonds for security. These days, however, the interest rates paid by bonds are sliding. Just last year, more than 32% of S&P 500 stocks had dividend yields greater than the 10-Year U.S. Treasury Yield. Hence, in today’s investment climate cash flow, income we receive from stocks could outpace that of traditionally higher-paying bonds.
My golden rule for guiding long-term investment strategies is the 15/50 Stock Rule. It’s straightforward. If you believe that you have at least 15 more years of living to do, your portfolio should be comprised of 50% stocks and 50% bonds and cash. As long as you are an investor with at least a moderate risk tolerance, this is a method to consider to strike a healthy risk/reward balance in your investment portfolio.
Considering the state of low-interest rates and bonds with paltry yields, the 15/50 stock rule could help you replace some of your bond interest with stock dividends instead.
The buyback or the dividend?
Recent data indicates that share repurchases have been on the rise and that companies choosing to pay stock dividends have stagnated. This is happening under the theory that these two methods are essentially equivalent.
Stock buybacks happen when a company repurchases its own shares of stock at market value and then reabsorbs ownership that was previously distributed among public and private investors. This inherently helps a company to increase its earnings per share, as there are fewer shares outstanding; however, it removes a major incentive for income investors to own these stocks.
So, are dividends and stock buybacks created equal? The short answer is no. There are benefits to both methods. When it comes to dividends, the most obvious perk is cash-in-hand — that quarterly income payment. For buybacks, these can increase your earnings growth rates, which can result in the market placing a higher value on the company’s shares. If you own shares in a company that does a buy-back, you are losing income but potentially gaining a higher share price due to increased earnings per share.
Personally, I think buybacks are great. But, given the choice, I’d rather have the dividends.
Tax treatment of dividends
Any discussion of investment strategies would be incomplete without the mention of taxes. I can hear the collective sigh, but stay with me: There’s good news here.
It shouldn’t be a surprise to learn that the IRS considers dividends paid by corporations to investors to be taxable income. But the good news lies in how Uncle Sam categorizes the dividends. At the Federal level, dividend income is typically taxed at a lower rate than ordinary income.
For most people, dividends are taxed at 15%. For those folks who fall into the two lowest tax brackets, there’s no tax on dividend income. For example, if you’re married filing jointly, your dividend income could be taxed at the 0% rate if your overall income is less than $74,900. On the other hand, those in the highest 39.6% tax bracket will be on the hook for 20% of the dividend payout. In every case, these numbers beat the tax levels on “ordinary income.”
Disclosure: This information is provided to you as a resource for informational purposes only. It 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. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.