Dividends are an ideal tool for generating income and growing your investment in the long haul. Moreover, compared to growth stocks, dividend stocks tend to be less volatile, reducing investment risks. But investing in dividend stocks requires a lot of background checks to help you make investment decisions with confidence.
Whether you are looking into investing in ETF dividend stocks or purchasing individual stocks, here’s a rundown of what you ought to consider before putting your money in:
Define Your Goals
Defining your financial goals helps refine the type of stocks you should pursue. Just like in other financial markets, the stock is only viable when you have clearly-defined goals. Essentially, dividend stocks serve two main purposes; maximize income or increase income over time. For investors focusing on growth, always look for equities with an increasing annual dividend growth rate. It is recommended to focus on growth rate data trailing 4 to 10 years.
Even for income-focused investors, it is imperative to consider the dividend growth rate. This ensures you maintain the buying power of your dividends. You also want to ensure that the stock has low debt and its growth rate beats inflation.
Don’t Ignore Trading Basics
Often, investors primarily focus on finding high dividend yields and overlook a stock’s fundamentals. A stock’s fundamentals entail the overall well-being of the company behind the stock. If the company is in financial turmoil and is not generating profits, the resultant effect will be low dividend rates.
However, it is common for companies to experience financial struggles at certain points in their life. So, be sure to check on the financial statistics of a company to get a sense of how the company recovered from past financial setbacks.
Look for Mid to Large-Cap Stocks
Mature and large companies usually offer the best dividend stocks. These companies rarely focus on growth and as such, much of their earnings are channeled back to shareholders as a dividend.
Also, since they already have established their operations, these companies have a consistent cash flow. This means that the companies won’t have trouble paying stable dividend yields.
However, small-cap stocks despite their high capital expenditure can also be an ideal investment for growth-focused investors. With sound management, the resources reinvested to grow the company will eventually pay off once the company reaches its optimal growth.
Decide How Much Stocks You Want to Buy
Similar to investing in typical stocks, you need to decide on how much you are willing to invest in any dividend stock. Ideally, the capital you invest should be an amount that you will not need anytime soon — at least not until you have garnered reasonable profits. As such, it is recommended that you have sufficient financial cushion to sustain you through the entire period as your dividends grow.
Additionally, consider your risk tolerance as well as asset allocation discipline. For less safe dividend stocks, you can allocate more money into them while investing less in highly risky stocks.
Understand the Tax Implications
When choosing dividend stocks, it is important to note that dividends are taxed differently depending on their category type. Generally, there are two main types of dividends; qualified and non-qualified. The qualified type is taxed at a lower capital gains tax compared to the high tax rate on an individual’s typical income. In most states, it is mandated that this type of dividend stocks must also be held for not less than 366 days.
However, your tax bracket can result in high taxation of your dividends yields. For investors in 10-12% tax bracket, your dividends are exempted from taxes. Investors above 22% tax bracket their dividend can be taxed as high as from 15% to 20%.
Non-qualified dividends are taken as short-term capital gains and are taxed at the same rate as regular income. Real estate income trusts are good examples of non-qualified dividend stocks.
When investing in dividend stocks, you should focus on long-term gains. The market is not fast-moving and investors need to take their time analyzing it. This gives you the advantage of compounding your returns to realize huge profits. You can also reinvest the dividend returns to further increase your payout ratio, while minimizing taxes.