Investing in the stock market offers up a great deal of both short-term and long-term benefits, and there may be no better example of the former than dividend stocks. By investing in dividend stocks, you stand to earn nearly immediate payouts once the stock earns a profit. If you aren’t familiar with the idea, you may be at a loss for how to best use that money. Fortunately, you have a wide range of options to consider, including those that turn your short-term gain into a long-term one.
How dividends are paid out
Jim Mueller, a Chartered Financial Analyst writing for Investopedia, notes that dividends are most commonly paid out quarterly but can also be distributed annually. Cash dividends pay out via a check that is mailed shortly after the ex-dividend date. The amount received would be equal to the declared dividend per share multiplied by the number of shares you own. As The Motley Fool writes, a $10 per share cash dividend for a stockholder with 1,000 shares would net a check of $10,000. A savvy investor could potentially use dividends as an effective second source of income.
There is also the possibility of receiving dividends through stock distribution. While opting for a dividend reinvestment plan would not net the immediate gratification of a quarterly or annual check, it provides the benefit of not being taxable until it is sold. In the case of the investor with 1,000 shares, a 5 percent stock dividend would result in 50 extra shares of company stock. Per Investopedia, cash dividends are taxed either at the normal rate or at a reduced rate of 5 percent or 15 percent. Holding dividend stocks within a non-taxable retirement portfolio like a Roth IRA would also shelter your gains from taxes until they are withdrawn.
How to use your dividends
If you are running a portfolio that follows the recommended ratio of 60 percent dividend stocks and 40 percent bonds, you stand to potentially make a substantial amount in dividends every year. If you receive dividends via check, consider that money to be income that can be used for any number of purposes — pay off a debt, make a down payment on a new car or take a vacation with you family.
Since this would ostensibly be income over top of your regular income, you may want to save it rather than spend it, particularly if you are working toward retirement. If you are receiving dividends from stock outside of a retirement package, you could reinvest that money in your 401(k) or Roth IRA. If you have a high-yield savings account or a money market account, saving money there is a surefire way to earn additional interest on a monthly basis.
A dividend reinvestment plan may be your best bet for longevity. Matt Krantz, author of “Investing Online for Dummies,” considers the advantages of a DRIP to be the ease of enrollment, automatic reinvestment, integration with direct stock purchase plans, lower or no commissions and the ability to purchase fractional shares. If you have confidence in a stock’s ability to continue to earn, a DRIP will maximize your earning potential by pulling in additional dividends for you over time, compounding your gains.
If both sound appealing, you can choose to split your dividend stocks between cash and DRIPs. This will ultimately allow you to determine which method is most preferable, and you can then adjust your payout as desired. For more on how to make the most of your dividends, speak with a trusted financial advisor.