There are more ways to potentially make money in the stock market than waiting for the value of your investments to grow. Enter dividends, regular payments some companies pay out just for being a shareholder. Here’s a look at how dividend stocks could help you diversify your portfolio and reach your financial goals.
What are dividend stocks?
Dividend stocks are company shares that periodically distribute cash or additional shares to shareholders. The distributed profits are called a dividend. Unlike growth stocks—or stocks that focus on putting cash toward expanding and potentially raising their share price—dividend stocks prioritize returning cash to investors. A company’s board of directors votes on whether and when to issue dividend payments. They’re usually paid quarterly, but they can happen annually, semiannually, or even monthly.
Advantages of dividend stocks
Dividend stocks could be appealing to investors for several reasons:
Regular income
Dividend stocks can provide a steady stream of income, valuable for retirees as well as investors seeking passive income. Typically, this income is paid regardless of share-price fluctuations, potentially offering some stability during periods of market volatility.
Potential for compounding growth
Many investors choose to reinvest their dividends, using that money to buy more stock. Come the next dividend payment, you could potentially get a bigger payment because you own more shares—and you potentially get more buying power to reinvest. Over time this strategy could boost both your dividend payments and your investments’ total value.
Generally lower risk than growth stocks
Typically but not always, companies that pay regular dividends are mature, well-established companies with stable operating margins and gross margins. Compared to growth stocks, dividend stocks are generally considered a potentially lower-risk investment. This could make them appealing to investors looking to reduce their risk and have a potential buffer in market downturns.
Risks of dividend stocks
As with any kind of investment, there could be drawbacks to investing in dividend stocks:
No guaranteed payments
A company’s dividend payment amount can drop at any time or be eliminated altogether—there’s no legal obligation for a dividend stock to keep making payments. Still, there are some companies that have kept and even raised their dividend payments for decades, even through recessions.
Limited growth potential
Because dividend stocks use their profits to pay investors, they may have less growth potential than companies that reinvest in their business. For investors looking for share-price growth who are willing to assume the potentially bigger risk that comes with that, dividend stocks may not be the best option.
Tax implications
Unless the dividend stock is held in a tax-advantaged account, like a traditional IRA or Roth IRA, dividend income is subject to taxes in the calendar year they are paid, which can eat into your overall return. In some cases, dividends are considered ordinary rather than qualified, meaning they can be taxed at a higher rate than capital gains tax rates—what you pay when you sell investments for a profit. Learn more about what makes a qualified dividend.
How to find good dividend stocks
There are a few factors that go into determining whether a dividend stock is a good fit for your portfolio. Here are 3 things you could investigate:
History of dividend payments
A strong indicator of a dividend stock’s likelihood to keep paying dividends is a track record of paying and increasing dividend payments over time, even in market downturns. But keep in mind past performance is no guarantee of future results. Still, some companies are considered “dividend aristocrats” for paying and raising their dividends each of the last 25 years.
Dividend yield
Dividend yield measures how much income a stock will produce. A high yield could mean the company is distributing a large chunk of its cash flow as dividends. That could be a good sign for short-term income but may not help with the company’s long-term share-price appreciation. Oppositely, if the dividend yield is low, it could mean the company is reinvesting more cash in hopes of growing the business. That’s possibly good for share prices but could come with lower near-term cash returns.
Payout ratio
A dividend stock’s payout ratio is the portion of a company’s net income or free cash flow used to pay its dividends. A low ratio indicates the company has solid free cash flow and may be able to sustain or possibly boost its payments in the future. A high ratio could mean a company is short on cash, or that the company is using a significant part of their profits to pay investors.
High-paying dividend stocks
If you’re interested in dividend stocks, you might also want to know which dividend stocks are likely to pay a significant portion of their profits to investors. Dividend yield is one way to narrow down investment options, though it’s not the only factor to consider before you buy. Investment firms offer tools to search for stocks with high dividend yields. Use the Fidelity Stock Screener to research high-paying dividend stocks.
Learn more about high-paying dividend stocks.
How to buy dividend stocks
If you decide you’d like to include dividend stocks in your portfolio, here are the steps to take to invest in them:
Choose and fund an account
Dividend stocks can be purchased in any account that can trade stocks, like a taxable brokerage account or a tax-advantaged account like an IRA. After you open an account or pick an existing one to use, transfer cash into that account so you have money to buy investments.
Research dividend stocks, mutual funds, and ETFs
Now for some homework. Look into different dividend stocks and other investments, like exchange-traded funds (ETFs) and mutual funds that could invest in collections of dividend stocks, to see which investments align with your financial goals, risk tolerance, and time horizon. Keep in mind those 3 key metrics: dividend history, dividend yield, and payout ratio. If you have an account with Fidelity, remember you could use our Stock Screener to help make that research easier.
Purchase your investment
Decide how much of that investment to buy and whether to make a one-time purchase or a recurring one. Here’s how to set up recurring investments.
What to know after you buy dividend stocks
After pressing “buy,” your job isn’t over. Here are 3 things to watch once you’re invested in a dividend stock.
The ex-dividend date
The ex-dividend date is especially important for new dividend stockholders. If you buy a dividend stock on the ex-dividend date or later, you wouldn’t be eligible to receive that dividend payout. If you hold a stock up until the ex-dividend date, you receive the dividend, even if you sell that stock on the ex-dividend date. Knowing this date could help you time your purchase and potential sale to avoid leaving money on the table.
Interested in seeing when a company may pay its dividend, and when the ex-dividend date is? Check out our Dividend Events page.
Whether to reinvest dividends
Many brokerages give you the option to reinvest your dividends, aka use dividend payments to buy more shares of that dividend stock. Choosing to reinvest or not is up to you, but check that your elections match your intentions. Here’s where to manage your dividend elections at Fidelity.
Your tax liability
Come tax time, if you’ve received at least $10 in dividend payments in a taxable brokerage account in a single calendar year, you’ll be able to see your year’s dividend payments on Form 1099-DIV. The financial institution through which you hold that dividend stock is responsible for providing that form to you by January 31 of the year after you receive those payments, so you can factor them into your tax filing.