Investing in the stock market is already a big step. But if you’re ready to make a few upgrades and make a little extra money through your investments that’s more than just capital gains, it might be time to try dividend-paying stocks.
What Are Dividend-Paying Stocks?
Dividend-paying stocks come from companies that pay a portion of their earnings back to investors. The payment can come monthly, quarterly, semi-annually, or annually, depending on the company.
“When you buy shares of a company, you actually become an owner of the company, which means you have a right to share in that company’s profitability,” says Dani Pascarella, Founder & CEO of OneEleven, a financial wellness platform. “Companies that pay dividends tend to be more established and have track records of consistent profitability.”
How Do You Make Money From Dividends?
Dividends pay their investors on a regular basis. It’s usually a percentage of a company’s earnings and investors can use it to reinvest into their portfolio or you can collect the dividend payments as income.
“The long-term average dividend yield of companies in the S&P 500 is just under 2%,” says Brian Walsh, CFP and Senior Manager of Financial Planning at SoFi, “But it is important to keep in mind that this will vary by company, sector, and the overall macroeconomic environment.”
Pascarella says dividends can pay anywhere from 2% to 5%, but some dividend-paying stocks can yield 8% or even more.
How to Know Which Stocks Pay Dividends
You can use stock screeners, news sites, and trading apps to find the most popular stocks that pay dividends. You can search by any variety you want, like the pay out time (monthly or quarterly, for example), industry, company, and other similar data.
Diversify your portfolio with dividend-paying stocks and securities. These pay investors every month, quarter, or year just for investing in it.
“No one can predict the future, so it’s impossible to know what the best dividend-paying stocks will be,” Pascarella says. However, there are some widely accepted guidelines that many investors believe are key for evaluating the investment worthiness of dividend-paying stocks.
Pascarella suggests asking yourself a few questions when it comes to finding dividend-paying stocks, like:
- Has the company consistently paid dividends over the past several years?
- Does the company have minimal debt, as evidenced by a low debt to equity ratio?
- Is the company growing every year with positive prospects for the future?
These can help you explore stocks that pay dividends and to find the ones that offer the best rate of return for your investments.
Limitations of Dividend Stocks
Dividends are enticing. They offer investors a return on their investment every so often on top of appreciation from stocks. But they have some limitations.
“Since dividend-paying stocks choose to pay a dividend rather than reinvesting that money in the business, it may impact future growth potential,” Walsh says. “So it is really important to consider your overall investment objectives before focusing on dividend-paying stocks.”
Walsh also says that dividends aren’t guaranteed. They’re only paid out at the discretion of the company’s board of directors.
Pascarella agrees, saying that if a company is paying dividends, it could slow their growth down since that money isn’t getting reinvested into the company.
“When companies choose not to pay a dividend, it’s usually because they’ve chosen to reinvest their earnings back into the company so that it grows faster,” Pascarella says. “The thinking here is that more growth will lead to more future appreciation in the company’s stock price.”
How to Invest in Dividend Stocks
If you’re ready to get started with dividend-paying stocks and other assets, you’ll need to do your homework first. Remember that diversifying your portfolio is one of the best ways to lower your overall risk. So spread out your investments to many different types of assets and securities.
“Select dividend-paying stocks that support your personal investment criteria,” Pascarella says. “Just because a company pays a dividend doesn’t mean that you believe in the company’s future growth potential or existing management’s ability to maintain the current dividend.”
Both Pascarella and Walsh suggest investing in an ETF that focuses on paying dividends. This gives you the chance to diversify your portfolio through spreading out your investments, but also allowing you to collect a payout.
“If you’re not sure which individual stocks to select, a dividend ETF that allows you to invest in many dividend-paying stocks through one investment could be a good way to get started,” Pascarella says.
When looking into which dividend stocks and ETFs to choose from, it’s also a good idea to explore payout times. Some companies pay dividends monthly and many pay them quarterly. You could get income on a regular basis when collecting dividends, which is enticing especially for investors who are using investment earnings as income. Look at a company’s investor page or check stock screeners for payout dates.