Want to make money from dividends? We have good news!
It’s a great time to start investing in the stock market and make money from your investments; so if you’ve been wanting to enter the stock market, now’s the time!
But do you really know how to make money from stocks?
From the stock market, you can
- make money from capital appreciation, and
- make money from dividends.
Capital appreciation is when you invest in a stock when its price is low, hold the asset for a suitable amount of time till its value appreciates, and then sell it at the increased value.
Most investors love this method and stick to it, but there is another way not a lot of investors explore.
Today we’ll look into the right way to make money from dividends! Every detail you need to know is right here; so read on to learn how to maximize returns from the stock market.
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What Are Dividends?
Dividends are monetary rewards that a company pays to its shareholders from their own earnings and reserves.
It’s like a thank you to shareholders for investing in their company. Besides just a reward of gratification, dividends also serve the purpose of
- returning a fraction of the company’s profit to its shareholders,
- attracting more investors,
- creating demand and increasing the market value of their stocks and shares, and
- displaying financial stability.
Note that companies aren’t obligated to pay dividends to their shareholders; in fact, most new companies (startups or medium-scaled businesses) use their profits towards further growth and expansion instead of paying out dividends.
Dividends are paid mostly by well-established companies as a reward to their shareholders for their investments.
When a company announces its dividend payout, they decide on a record date for all of its registered stockholders.
On that date, all the shareholders of the company receive a dividend proportional to the number of shares they hold.
Types of Dividends
Typically, dividends can be paid out in 5 ways:
- Cash: The most common method of dividend payout companies use.
- Stock: The company can pay dividends in the form of new stocks of the company to current shareholders.
- Scrip: Companies can also pay scrip dividends, which are promissory notes that may or may not bear interest, and usually come with a maturity date.
- Bond: Some companies use bonds to payout, which notifies a future date when they promise to pay the dividend. Dividend payouts done through bonds always bear interests.
- Property: It’s a popular form of dividend payout (although not so much in India) where the company chooses to distribute its superfluous assets or own products as dividends.
Important Terms to Know Regarding Dividends
A dividend is paid when a company earns an annual profit and chooses to reward its shareholders for their investment in the company.
Companies have a board of directors who discuss with the company leaders how they should divide the profit.
What percentage of the profits should be used towards the growth of the company, and what goes out as dividend payouts?
2. Dividend Yield
The dividend yield is the percentage of the dividend-to-price ratio that represents a company’s dividend payout per year with respect to its stock price. The reciprocal of this dividend yield is the price-to-dividend ratio.
One important thing to keep in mind is that investors often make the mistake of always associating a high dividend yield with a lucrative investment opportunity.
However, the real scenario might be far from this. A stock’s dividend yield can also increase due to a decline in its stock price.
How to Make Money From Dividends
1. Invest in Stocks That Pay Dividends
This is the most obvious advice, but we’ll start with it nonetheless. Invest in stocks that actually pay dividends. That’s the surest way to make money from dividends.
It’s the age-old saying, “You cannot win if you don’t play”.
Hence, make your way into the dividend investment arena as soon as possible and start investing! Keep adding money to your highest dividend-paying stocks, and you’re set to make the most money out of dividends.
Here’s where to look for stocks that pay dividends:
- Industries and various sectors that are rich in dividends.
- Websites specially built to help you invest in dividend stocks.
- Mutual funds and ETFs focused on dividends.
- Services or products you regularly use.
We also have some fool-proof tips that’ll take you a long way when you’re out to make money from dividends.
- Get a thorough understanding of how the company works.
- Determine what the forward yearly dividend yield is.
- Go through their historical data for dividend growth.
- Calculate the payout ratio.
- Estimate the financial status of the company and evaluate dividend safety accordingly.
- Review the valuation of their stocks.
If you’re not fully confident to go through these parameters by yourself and make a concrete decision, you can also apply for dividend funds and websites that offer stock recommendations.
A great source of finding sound dividend stocks are exchange-traded funds (ETFs) and mutual funds.
They usually do all the searching and decision-making on your behalf; all you have to do is invest in the stocks and own the best companies to make money from dividends!
One such site is Dividend.com which helps you build a diversified dividend stock portfolio.
2. Reinvest All Your Received Dividends
A good way to keep snowballing your wealth from dividends is to reinvest the dividends received. You can reinvest them into the stocks you already own or look for more new dividend stocks.
This is basically a way to generate dividends from dividends and get the chain ball rolling.
The convenient thing about this method is that you don’t have to put any money from your own current wealth into stock dividends; they’re just “on the house”!
If you have an investment/stockbroker, you can consult them to help you put the dividend return back into the company’s stock investment.
Another method you can opt for is to accumulate the dividends for a few years and reinvest them all at once.
This way, your returns can grow, you can diversify your dividend stocks by investing in different companies, and manually decide which stocks to reinvest in and which ones to drop.
3. Start Investing For Higher Dividend Yields
Remember our definition of Dividend Yield? That percentage is a big deciding factor in how much you make from your dividend stocks.
For example, if you invested $1000 in a dividend stock with a dividend yield of 3%, you will make an annual $30 worth of dividends. So, the simple trick is to invest in stocks with higher dividend yields!
Now, if you invest the same $1000 in a 5% dividend yield stock, you will make an annual $50 in dividends!
Here’s a fair warning, though: the higher the dividend yield, the higher the risk of your investment. Dividends in such investments can either be high or reduced to negligible; worst-case scenario, the company might even suspend its dividend payout in the future.
4. Make Investment for Dividend Growth
Investors use an efficient strategy for active dividend growth where they buy and hold a portfolio or collection of shares.
You can invest in dividend growth and increase your portfolio by adding companies that have a reliable track record of dividend payouts over several years.
Smart dividend growth investors don’t tirelessly trawl through financial pages in hopes of finding some good buys; they have specialized brokers or screening tools that assist in estimating dividend stocks!
These kinds of investors diversify their portfolios to create an income-generating machine!
The annual dividends in their bank accounts are their scale of success rather than the current market values of those stocks.
5. Swap Portfolio Holdings
A lot of your stock prices might vary with time. Similarly, some of the dividend-paying companies you have invested in might increase their payout rates faster than other companies.
You have to recognize the opportunities that follow these varying conditions.
Swap some of your present stock portfolio holdings with better and new ones, or take out some cash from some of your current stocks and invest them into new ones!
The goal is to expand both your dividend growth rate and portfolio dividend yield. Always stay agile and ready to move around your investments to make money from dividends!
6. Keep down on Income Taxes
If you want to make money from dividends, you also have to be prepared to pay some hefty income taxes. Income tax, among other things, is one disadvantage of accruing dividends.
However, there are ways to minimize taxes on dividends or even eliminate them altogether!
Individual Retirement Accounts (IRAs) are the solution. Not only do you avoid taxes this way, but you also get to save for your financial independence in the future!
IRAs help you generate dividend payments every month as a supplement to your other income sources after retirement.
If you’re interested in IRAs, you can try M1 Finance for a plethora of convenient investment options on dividend stocks online, completely free of charge!
Important Things to Consider Before Dividend Investing
1. Dividend Yield Percentage
Always have a clear idea of the stock’s dividend yield before investing in it.
One of the most important check-points is the yield percentage, as opposed to the dividend per share!
2. Financial Health Of The Company
Make sure to do a complete analysis of the financial health of the company.
Check their balance sheets and find out more about their debts; a big debt or continuous decline in revenue are indicators of poor dividend payout in the future.
3. Dividend History
Since companies aren’t obligated to pay dividends and do it out of their own volition, it’s best to analyze the company’s dividend history before investing in stocks.
Some companies can reduce the payout rate or stop paying dividends altogether!
4. Profit Growth Rate of that Company
A company’s profit growth rate (especially the top and bottom line) can prove useful in estimating the company’s future dividend payouts.
Taxation is a serious consideration when you’re trying to make money from dividends.
If you receive dividends from an Indian company, you will be taxed at a 10% rate only if your income from these dividends exceeds INR 10 Lakhs.
Dividends from foreign companies fall under “Income from other sources”, so they are taxed accordingly.
How to calculate dividends?
You can easily calculate your dividends using a per-share estimation.
Say, you have 100 shares of a company that pays dividends at the rate of $3 per share, then your annual dividend income from that company will be $300!
How do I know what stocks pay dividends?
Look through the company’s investor relations site or listing exchange information like NYSE, Nasdaq, etc.
These pages usually contain the company’s dividend information. But here’s a pro tip: we suggest you invest in larger, well-established companies if you’re looking for stocks that pay dividends.
Do dividends increase over time?
Yes. Successful, well-established companies have kept increasing their dividend payout continually over the years.
If you hold the same stocks for a prolonged time, your dividends increase while the cost price of the stocks remains constant.
This means a steady appreciation in dividend yield because the numerator (yearly dividend) keeps increasing with a constant denominator (stocks’ cost price)!
Can you really make money from dividends?
Yes, given that you choose the right dividend-paying companies. Small amounts of dividend income every year will accumulate over time to build you a large wealth.
Hold on to your high dividend-paying stocks, and you can expect a healthy flow of return from these investments over time.
So, now you know that capital appreciation is not the only way you can make money from stocks.
Buying low and selling high, keeping an eye on your investments, and always on the lookout for the right moment to sell them to make a reasonable profit isn’t your only path into the investment arena.
Several long-term investors’ favorite earning source is annual dividends; they even build wealth with their dividend income!
Dividends are perfect for you if you don’t like the idea of selling your stocks to generate income.
Go ahead and look for companies that pay dividends today! We hope this article answered all your doubts and queries about how to make money from dividends.
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