Dividend Income Strategy
Receiving steady dividends from income investments can be one of the most rewarding (and profitable) benefits of managing your own investments.
As you build a diversified portfolio containing many different dividend-paying stocks, the will dividends start rolling in every week or two, you’ll see your net worth rise more consistently, and you’ll be watching your investments much less.
But once you start investing for dividends successfully, you’ll want more and more. And dividends can offer you that if you choose the right dividend income strategy.
There are a number of historically proven dividend income investment strategies which work. They may be different, but the foundations of all of them are the same. All dividend income strategies should be focused on three following points which will affect how much dividend income comes into your bank account each year:
1. How to Boost Your Investment Returns with Dividends
Dividends are one of the best ways to increase your investment portfolio performance for a number of reasons.
The first reason is the most direct. A dividend-paying stock pays you cash while you’re holding it. You can take the dividend yield and add it directly to any capital appreciation of your investments to determine the total return of your portfolio. Whether the dividend income portion of the total return is a relatively low 2% or 8% or more, dividend income goes right to your portfolio’s bottom line.
The second reason is a bit more hidden. In order for a company to consistently pay out dividends, it must be in stable financial condition.
Your editor has long said profits can be made with accounting tricks. Dividends must be paid in cash.
And it’s true. This reality means a company must have a strong enough core business to be able to meet the dividend payments its shareholders expect. Because if the company can’t make the dividend payments, you can bet the share price will take a big hit as dividend investors walk away and management won’t be employed for long.
Furthermore, one of the best indicators a company or sector is facing troubles the outside world might not realize yet is when they cut or eliminate their dividend payments.
When the big banks started cutting dividends in early 2008, your editor took that as a dire warning sign. We pounded the table on getting out of bank stocks. Six months later all the major banks which cut or eliminated their dividends were bankrupt or bailed out. The dividends didn’t lie.
The third and final reason dividend-producing investments will increase your portfolio return is because of structural changes affecting the world we live in.
One major change is that the world – and especially North America – is getting older. Older investors are naturally more conservative and often turn their focus from capital gains to generating the most income from their investments.
They inevitably turn to dividend income to supplement their other sources of income like government and private pensions. This major demographic shift will put dividend-paying stocks even more in demand than they have been in decades.
The other major change affecting dividend income investments is the period of “Financial Repression” we have entered. One of the core tenets of financial repression is ultra low (and sometimes negative) interest rates. This makes bond and other types of fixed income investments pay out very low levels of income. As a result, dividend income of 3% and 4% or more becomes increasingly more in demand.
Dividend investing is not always the most exciting investment strategy. However, the best investment strategies which deliver consistent and stable returns rarely are anything close to exciting.
2. Diversify and Get More Dividend Income from Investments
The key to any investment strategy – dividend income investing included – is diversification.
The goal of a dividend income-focused portfolio should be to own a broad basket of dividend-paying stocks across a number of sectors to be truly diversified against major market moves and the even larger swings within different sectors.
One classic example of getting greater diversity and higher income at the same time is one of the best and most popular dividend stocks publicly available, Annaly Capital Management (NYSE:NLY).
The company essentially borrows money at a low rate and buys (now government-backed) mortgage securities and pockets the difference. It also pays shareholders a dividend yield well into the double-digit rates. It’s one of the highest and safest dividends out there.
Annaly’s dividends, however, do not come without risk. Its shares are actively traded and they will move up and down as interest rates move up and down. As a result, the attractive dividend Annaly pays was (and will be again at some time) worth buying the stock to get. However, one stock and one dividend payment – regardless of how high and secure it may be – should not be the focus of an excessively large portion of your portfolio.
3. Dividend Income and Taxes
The final consideration for any investor focused on dividends is taxes.
Most dividends are taxed just like other sources of income. So if you’re in the 25% tax bracket, 25% of your dividends will be paid in taxes.
Qualified dividends receive special treatment under current tax codes. A qualified dividend is any dividend income coming from shares own
Three criteria must be met for ordinary dividends to receive qualified dividend tax treatment:
1. Dividends paid by a U.S.-based company or a qualified foreign company
2. Dividends coming from investments held for a certain period of time, normally at least a year
3. Dividends which are not specifically disqualified by the IRS
The tax treatment of dividend income must be included in any dividend income analysis because taxes reduce the effective yield on any dividend-paying investment.
Contrarian Insights believes high-yield dividend investing we’ve devoted an entire section of the web site to high yield investing.
Executive Editor, Contrarian Insights
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