Dividends can be an important source of income. However, there are several factors you should take into consideration if you’ll be relying on them to help pay the bills, especially if you are no longer earning income.
An increasing dividend is generally regarded as a sign of a company’s health and stability, and most corporate boards are reluctant to cut them. However, dividends on common stock are by no means guaranteed; the board can decide to reduce or eliminate dividend payments at any time.
Investing in dividend-paying stocks isn’t as simple as just picking the highest yield; consider whether the company’s cash flow can sustain its dividend, and whether a high yield is simply a function of a drop in a stock’s share price.
Because a stock’s dividend yield is calculated by dividing the annual dividend by the current market price per share, a lower share value typically means a higher yield, assuming the dividend itself remains the same.
Also, dividends aren’t all alike. Dividends on preferred stock typically offer a fixed rate of return, and holders of preferred stock must be paid their promised dividend before holders of common stock are entitled to receive theirs. However, because their dividends are predetermined, preferred stocks typically behave somewhat like fixed-income investments.
For example, their market value is more likely to be affected by changing interest rates, and most preferred stocks have a provision allowing the company to call in its preferred shares at a set time or at a specified future date. If you have to surrender your preferred stock, you might have difficulty finding an equivalent income stream.
Finally, dividends from certain types of investments aren’t eligible for the special tax treatment generally available for qualified dividends, and a portion may be taxed as ordinary income.
Note: All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful. Investing in dividends is a long-term commitment. Investors should be prepared for periods when dividend payers drag down, not boost, an equity portfolio. A company’s dividend can fluctuate with earnings, which are influenced by economic, market, and political events.