When a company turns a profit, what happens to the money that they receive? The business usually has two simple choices: they can keep the cash within the company, or they can give the money back to the people who invest in the company. These payment given to investors from the company’s earnings are known as dividends.
How you choose to spend any dividends you receive now plays a vital role in defining your investment strategy as a winning one. There is no easy answer. You should be making your dividend decisions based on your current situation, and as part of your long-term retirement planning. In other words, when it comes to dividends, you do you. But before you take your first dividend check and blow it on bottle service, make sure you are aware of your options.
To Spend or to DRIP? That is the Question
Many people reinvest their dividends back into their investment, allowing them to accumulate more and more shares as time goes on, thereby increasing their overall stock position. If you choose to go this path, you will likely see the term DRIP, which stands for Dividend Reinvestment Plan.
Using a DRIP run by a brokerage firm or the by company itself, you can purchase additional shares with your dividends. DRIP shares come from the company’s reserve, so when you decide to sell them, you are required to sell them back to the company at market value.
The goal of many people who invest in high dividend-paying stocks is to live off of the profits in retirement. This strategy entails a portfolio big enough to generate high dividends on a regular basis. To do this, you leave the principle untouched so it can earn you more. The concern is that when retirement comes, your portfolio earns 3%, but you withdraw 6% for living expenses. Because there is no way to know what the market will look like then, living off of your dividends does carry some risk.
Dividends Don’t Grow on Trees (Unless you invested in a tree-related stock)
Profits can come from any investment, but there are differences worth knowing when deciding on an investment strategy. Established firms are more likely to pay dividends on a regular basis, as compared to newer companies that may use earnings to reinvest back into the company. Tech companies frequently use this strategy and rarely pay dividends.
One option that shareholders can execute is to invest in individual companies known for paying dividends on a regular basis. Dividend stocks, which are merely stocks that have a long history of paying out dividends, are perfect for someone seeking income in addition to returns.
According to U.S. News & World Report, some of the recent top dividend stocks include:
- Broadcom Inc (AVGO): 5.81% one-year returns. 2.66% dividend yield.
- Suntrust Banks Inc (STI): 32.91% one-year returns. 2.27% dividend yield.
- Vail Resorts Inc (MTN): 22.69% one-year returns. 2.27% dividend yield.
As solid as those numbers may look, you need to remember that anytime you are investing in a single company, you’re putting all your eggs in one basket. Investing in high-yield dividend stocks may be attractive, but any investor knows that you need diversity to protect yourself over the long-term.
ETFs: “I like the high-yield performance, she likes the security of a diverse fund.”
In 1993, investors and traders were looking for ways to invest in multiple high-performing stocks at once with a lower risk factor. Thus, the exchange-traded fund (ETF) was born, and within a decade its popularity among investors has skyrocketed. Currently, ETFs hold net assets amounting to $1.34 trillion; that compares to $14.72 trillion in total assets held by investment companies, like mutual funds.
Most (but not all) ETFs are designed to mimic index funds, as they share a common goal: generate a benchmark return at minimal cost to investors. One advantage of an ETF is that unlike an index fund, it often trades commission-free, which is attractive to investors.
Here are some of the current top-performing ETFs, according to Investopedia:
- WisdomTree U.S. Quality Dividend Growth Fund (DGRW)- 26.77% one-year return, 1.69% dividend yield
- iShares Core Dividend Growth ETF (DGRO)- 22.41% one-year return, 1.92% dividend yield
- First Trust NASDAQ Rising Dividend Achievers ETF (RDVY)- 22.07% one-year return, 1.18% annual yield
As you can see, just deciding that you want to start receiving dividends on stocks is not enough. To ensure you are making smart moves designed to move you towards your long-term financial goals, staying aware of the various dividend options and vehicles is crucial.
Dividend and conquer
Whether you are planning for retirement or just seeking some short-term earnings from a high-yield stock or fund, how you choose to handle dividends is an important decision. With Stockpile, you have the freedom to invest in stocks, ETFs, or a combination of both—whatever fits your investment strategy. And not only can you reinvest your dividends, but Stockpile will only charge 99¢ in trading commission.
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