Dividend Stocks and Tax-Advantaged Accounts

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It’s true that one of the reasons that many people begin investing in dividend stocks is because of the potential for income. Income investing with dividend stocks can help you build up a revenue stream that you can use to cover day-to-day expenses. However, not everyone uses dividend stocks as a way to provide income. In some cases, dividend stocks can be great for building up a nest egg quicker. In such cases, some planning to reduce your tax liability it in order.

Holding Dividend Stocks in Tax-Advantaged Accounts

If you have a more long term strategy for your dividend investments, you should consider where you are holding them. When you receive dividend payments, you have to pay taxes on them. This means that the value of your gains is eroded. If you are using your dividend investments to reach long term goals, paying taxes on income that you aren’t planning to use doesn’t make much sense. This is where tax-advantaged accounts come in.

A tax-advantaged account is one that allows you some sort of tax-break. Earnings from these accounts have different rules applied, and that can mean that you build wealth more efficiently with your dividends. If you hold dividend paying stocks in a tax-advantaged account, your dividend earnings aren’t taxed when you earn them.

If you hold your dividend investments in a tax-deferred account, such as a 401k or a traditional IRA, you won’t have to pay taxes on the dividends until you withdraw money from your account. It gets even better if you have a Roth account. For dividend investments held in a Roth account, you don’t have to pay taxes on your withdrawals, so your earnings are tax-free. DRIPs can be especially helpful int these situations. That’s pretty smooth.

The great thing is that this allows you to reinvest your dividends without any tax costs to erode the value. You can increase your efficiency, and earn more over time. It’s a great boon to the investor, especially the dividend investor who doesn’t expect to use the earnings from his or her dividends for decades.

Considerations

Before you use this strategy, though, you want to make sure that you understand the rules and limits that come with different tax-advantaged accounts. As long as you meet the requirements, you can gain a huge advantage by picking and choosing where you hold your long term dividend investments. If you plan correctly, you can maximize your dividend dollars.

3 Tips for Successful Dividend Investing

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Many people are looking for the perfect formula to help them figure out how to invest successfully. However, there is no one magic formula that can guarantee adequate stock returns. Instead, it requires planning and effort to successfully build up your dividend portfolio. While there are many things that you can do to improve your results with dividend investing, here are 3 tips that I’ve found especially helpful when it comes to choosing good stocks for your dividend portfolio:

1. Get Educated

Learn about dividend stocks. Learn about how they work, and learn about how to evaluate yield. Find out more about what makes a quality dividend stock, and how to determine which stocks are more likely to help you meet your goals. Educate yourself about companies you are interested in, and familiarize yourself with terms common to investing and dividend investing. Learning how to choose dividend stocks, and understanding how money and investing work, can go a long way toward helping you find success as a dividend investor.

2. Focus on High Quality Stocks

Instead of looking only at dividend yield, consider looking at other factors that make a high quality stock. Look at companies that have a long history of stable growth, and that pay out dividends regularly. Dividend aristocrats are generally good choices, and show high quality. Companies that are cash rich can also be good choices, since it usually indicates that they are doing something right – especially when they use some of that cash to reward shareholders by paying dividends.

3. Make a Plan and Stick With It

You are much more likely to do well when you create a dividend investing plan and then stick with it. Think about your long term and short term goals, and determine which dividend stocks might be able to help you reach those goals. If you are educated about your options, and if you focus on high quality stocks, you should be able to create a plan to fit your needs. After that, you will need to stick with your plan. When you get too emotional, or sell at the first sign of economic trouble, you could upset your long term goals. If you have a good plan, make an effort to stick with it. While you might need to reconsider some of your investments if something changes fundamentally about a dividend stock, but, overall, it’s a good idea to stick with your plan.

REIT Dividends Could Suffer from Debt Downgrade

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All the news focus right now is on the possibility that the U.S. debt ceiling will not be raised, and that the U.S. could begin defaulting on its debt. This news has many investors worried, and looking for good dividend investing choices, just in case everything goes south.

Interestingly, some of the biggest losers from debt default, and the resulting credit rating downgrade, would be real estate investment trusts (REITs). It is very likely that REITs would suffer — and so would their dividends. This is because a credit downgrade would make U.S. Treasury debt more expensive. A downgrade represents an increase in risk. Without the sterling rating that U.S. Treasuries have enjoyed for decades, investors would demand higher yields on the bonds. Additionally, the paper held by REIT portfolios made up of debt insured by government agencies (Fannie, Freddie), would also suffer the same sort of downgrade.

Mortgage rates and other interest rates related to real estate are closely tied to the rates on Treasury notes (especially long term Treasuries). As the yield rises on Treasury notes, other interest rates rise as well, making it harder to borrow money. In some cases, this is vital when it comes to the ability to own real estate and find holdings for REITs. With REITs suffering, dividend payouts might be cut.

In the end, a possible debt default in the U.S. would have far-reaching consequences. It doesn’t seem as though politicians are able to find common ground as it relates to taxes, spending cuts and other conditions for raising the debt ceiling. As a result, it is a very real possibility that a deal may not be reached. It might be time to re-examine your portfolio, and make changes to the way you are doing things. It might be time to position yourself to take advantage of opportunities that can crop up during times of economic upheaval.

Roundup: What’s Next?

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Often, when making investing decisions, we need to have an idea of what’s next. Whether that includes making decisions based on what we think will happen with the economy, or with a specific investment, or whether we try to plan what’s next based on our own finances. If you are interested in getting ready for what’s next, here some posts to consider:

  1. Valuation-Informed Indexing #52: The Realities Overvaluation Are Hard to Accept: As you try to decide what to do next with your investments, you need to confront the realities of overvaluation. Rob Bennett at Value Walk takes a look at overvaluation and how it can be a problem.
  2. Do You Need an Emergency Fund?: Mike at the Oblivious Investor takes a look at how you can prepare for the future. If you have the right portfolio size and liquidity, you might be able to get rid of your emergency fund.
  3. Do You DRIP?: If you are interested in keeping things going for the future, you might try a DRIP. Dividend Mantra takes a look DRIPs — and why he doesn’t participate in these plans.
  4. 6 Strong Companies with Double Digit Dividend Growth: If you are interested in investing in companies with strong potential, Matt at Dividend Monk offers some good ideas. He takes a look at 6 companies that might help you reach your goals.
  5. How To Choose Which Account To Invest From: The Passive Income Earner has some practical advice for figuring out which account to use when investing. No matter what’s next, this insight can help you make better decisions.
  6. Index trackers: The good, the bad, and the ugly: If you want a brighter future, it helps to understand your choices when it comes to index trackers. The Accumulator at Monevator offers some helpful insight into which index trackers are likely to help prepare you for what’s next.
  7. A Look At My Latest Trades: Enjoy some good ideas and some solid insight with this post from Mike at The Dividend Guy. Figure out what you can do to improve your portfolio performance.

Cash Rich Companies: Time to Increase Dividends

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One of the side effects of the financial crisis and the subsequent recession has been the tendency of companies to hoard their cash. Many companies cut dividends, or did away them altogether, during the recession. There are some companies that are sitting on piles of cash right now. Many companies have been seeing better than expected earnings, and all of that cash could be put to different uses. One of those uses might be increasing the dividends they pay out to shareholders.

Using Dividends to Attract Investors

Many companies use dividends to attract investors. In some cases, these companies offer dividends that are unsustainable in order to bring in investors. While you can get some good opportunities with these types of stocks, you might not want to invest in a company that could cut dividends quickly. If you are looking for income investments, considering companies with lots of cash might be a good idea. These companies are generally strong companies, and often include dividend aristocrats that regularly increase payouts.

Companies devoted to rewarding their shareholders when they have extra cash are more likely to attract long term investors – investors who are likely to stick with the company over the long haul. And investors can get decent returns. Indeed, many dividends stocks are providing better yields than what could be had with Treasury bonds and many corporate bonds right now.

Some Companies Do Other Things with Cash

Not all companies pay out more dividends when they have the cash. Instead, some companies initiate stock buy backs, or make acquisitions of other assets. Indeed, Microsoft recently used some of its piles of cash to spend billions to buy Skype. No dividends there. In other cases, companies reinvest their cash in equipment, advertising or other assets meant to help grow market share or increase profitability over the long run.

For some investors, though, this is a worthwhile exchange. Rather than getting dividends, some investors are content to benefit from a share price that goes up on mergers and reinvestment moves that turn out well. Investors looking for regular income, though, are more likely to decide to go for dividends, since they provide the opportunity to for people to create an income portfolio that can offer stability for years.

Bottom Line

Your investing goals will help you determine what you prefer. If you want to build an income portfolio, choosing companies that give cash back to shareholders is ideal. If you are more interested in growth and returns, looking for companies that reinvest, rather than paying cash to shareholders.

Choosing Dividend Stocks With Cash Flow

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When it comes to choosing a dividend stock, many of us are tempted to look solely at items like dividend yield or dividend growth. A stock with a high yield, or a recent history of big hikes, might seem especially tempting. However, we shouldn’t always just look at how a company is doing now in terms of dividend yield, or the past trends associated with dividend growth. It is also important to consider the fundamentals, including the state of a company’s cash flow and cash reserves. A snapshot of the company’s financials in the last couple of years can be quite telling.

Why Cash Matters to a Company

As you consider different options for your dividend portfolio, it is important to look at what different aspects of a company’s finances say about the company as a whole. Cash can tell you a few things about the strength of a company:

  • Cash reserves usually mean that the company spends less than it earns.
  • How the company spends money can indicate what is important to it. If a lot of money flows to people at the top, or if more of it goes to reinvesting in the company’s developing, can say a lot about the future success of a company.
  • A cash rich company can usually keep paying a dividend – and is less likely to cut payouts when the economy (and the market) is in a downcycle.

Taking a look at the cash habits of a company can provide a good indication of how long it can keep payouts at the same level. If you see cash reserves dropping, it might be a sign that dividends are about to be cut. When there isn’t any cash to spread around to shareholders, it soon becomes evident that dividends will have to cut, and you could find yourself in trouble.

For some, cash isn’t important. If you have short-term goals for your dividend portfolio, it doesn’t matter as much if the company is likely to cut dividend payouts. With a large chunk of capital, you can do well for a year or two with a high yield dividend stocks. Then, you can sell the stock before the price drops and the dividend is cut.

Others, though, find it a better idea to invest in cash rich companies that pay dividends. Companies with sound financial practices and plenty of cash are more likely to provide stable income for you. If you have long-term income requirements for your dividend portfolio, the company’s financials should be carefully considered before m

Should You Rebalance Your Portfolio?

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One of the questions that many have about their dividend portfolios is this: “Should I rebalance?” The answer, of course, depends on your investing and dividend goals. If you have a long-term investing plan for your dividend portfolio, hoping for growth in the stocks you hold as well as benefitting from the dividends, rebalancing becomes quite important.

What’s Your Target Allocation?

The first thing to do is remind yourself of your target allocation for this portfolio. In some cases, your investment plan might call for a shifting target allocation, depending on where you are at in life. Consider your current position, and think about what your dividend portfolio should like right now. Then, review your dividend portfolio. You might be surprised at how recent additions might have skewed your portfolio. Additionally, if you have dividend funds, you might find that changes to the funds themselves might have changed your asset allocation. If your asset allocation doesn’t reflect your current position and plans, you need to rebalance.

Are You Unhappy with Your Level of Diversity?

Next, you need to look at the level of diversity in your dividend portfolio. Are you unhappy with it? Consider your goals, and consider the latest industry news. You might be unhappy with your current level of diversity, and interested in changing matters. Review your dividend investments, and make sure you aren’t relying too heavily on one industry, or one asset class. You could find yourself in trouble if that one area runs into problems and everyone starts cutting dividends – or if everyone tanks close to your target retirement date. Dividends aren’t much use if you were planning to sell the stocks and do something else with earnings. If you don’t have your desired level of diversity, rebalance your portfolio until you do.

Individual Stocks

You should also consider your feelings about the company itself. Do a little fundamental analysis. Has something changed about the company at the most basic level? If you are unhappy with some of the companies in your portfolio due to management changes, profit margin shrinkage, or loss of market share, it might be time to pull out and look for another option. It’s also a good idea to be wary of dividend stocks that have experienced a lot of cuts to pay outs recently. This is especially important if you rely on your dividend portfolio for a revenue stream. If too many cuts are affecting your income, it might be time to rebalance your dividend portfolio so that your income is restored.

Bottom Line

Take time at least twice a year (or as much as every quarter) to consider your dividend portfolio. Make changes as necessary so that your portfolio continues to reflect your current needs and future goals.

Why Invest In Dividend Paying Stocks

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Many people wonder why dividend paying stocks make such good investments. After all, it doesn’t seem like much to be paid a few cents a share. When a good plan is followed, though dividend paying stocks can be a good addition to any portfolio – especially if you are looking for an eventual source of income. As you invest in dividend stocks, remember that it takes time and patience to build up a solid dividend income portfolio.

Dividends Provide Some Comfort in a Volatile Market

When the stock market is volatile, it usually doesn’t matter what the company is: You will end up with lost value. Dividend stocks are no different; the share price is just as likely to drop in a down market as all the other stocks heading down. The dividend advantage is seen as you continue receiving a payment for your shares. If a company has solid fundamentals, it is likely to continue paying a dividend. This means you still get some benefit – even in a volatile market.

Dividends Often Keep Up with Inflation

According to SagePoint Financial, dividends normally keep up with inflation. Indeed, if you are concerned about inflation eroding your wealth over time, dividend stocks can help you avoid that fate. Plus, companies that pay dividends are often financially sound (unless they are offering a yield that is quite high; that might be a sign of trouble). This financial soundness is likely to stand companies in good stead in the future, and owning them could mean that eventually the stock’s value will rise as well. This, plus the dividends, means that you will most likely go beyond keeping pace with inflation, and actually beat it.

Things to Remember when Investing in Dividend Paying Stocks

It is important for the beginning investor to remember, though, is that dividend investing doesn’t result in immediate money in your pocket. Unless you have a great deal of capital to buy up a large amount of shares, the immediate impact to your finances will be small. Instead, you need to plan for a time frame of seven to 10 years of regular investing to see an improvement in your income, as well as true value gains for the stock in question.

Also, make sure to do your homework. Research is important when you are buying dividend stocks. The top dividend stock membership can help investors identify stocks with solid yields and dividend growth. Make sure that you are comfortable with the company, and that the yield makes sense for the company. If you plan on using dividends for income later, you want to make sure that you have chosen solid companies with a good chance of success.

Roundup: Financial Freedom

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We’re all looking for financial freedom in some form or another. One way to achieve that is through making prudent investments and sticking to your plan. If you are interested in achieving financial freedom, you can get help from these blog posts:

  1. Financial Freedom At 45: A great post on financial freedom, and how to get there. The Passive Income Earner lays out a plan for financial freedom (not necessarily retirement), and offers great insights on what you can do to be financially free.
  2. The Millionaire Teacher: Over at the Dividend Ninja, you can learn about the Millionaire Teacher author Andrew Hallam through an interview. Great insights on how to find your path to financial freedom.
  3. How To Build Wealth Wealth and Eliminate Debts: If you want to be financially free, you need to learn how to get rid of debt and build wealth. Buy Like Buffett provides you with some help in this arena. Lay the groundwork for financial freedom, thanks to these tips.
  4. How To Build A Solid Dividend Retirement Portfolio: Looking for help with financial freedom in retirement? The Dividend Guy offers you some ideas for putting together a solid portfolio. Start now, and you’ll reach financial freedom.
  5. 3 Model Portfolios to Consider: If you want to build financial freedom, you can use these model portfolios to help you on your way. Dividend Monk puts together three different portfolios for those interested in using individual stocks in their plans for financial freedom.
  6. Finding Investment Treasures in International Markets: Use this post from Value Walk to improve your chances with international markets. Diversifying to international assets can help you reach your goals of financial freedom.
  7. What Are Your Dividends For?: As part of your efforts to become financially free, you should have a plan. Dividend Mantra shares some insight into deciding what’s important to you, and using your dividends for that purpose.

What Does a Dividend Say About a Company?

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Some investors, when picking stocks, like dividend paying stocks. This is because a company that pays a dividend generally had certain characteristics. These characteristics can make a company a good investment – beyond the virtues that the dividends have for income investing. Here are some of the things you can infer about a company from its dividend:

Financial Strength

One of the most important things you can learn about a company from its dividend is its strength. A company can’t pay a dividend if it doesn’t have cash. The payment of a dividend is usually an indicator that it has some cash to spare. (You do have to be careful, though; in some cases a very attractive dividend is an indication of the opposite, with a management desperate to find investors to shore up the company finances.) A regular dividend that remains stable, or increases every year (like what you see with dividend aristocrats), is usually an indication that the company knows what it’s doing financially.

Stability

A regular dividend can also indicate that the company is stable. A reasonable yield of between 3% and 6% usually means that there is a degree of stability in the company. This is especially true if the payouts have remained the same, or risen, over time. If dividends are being slashed, or if there is an erratic history of payouts, it can be an indication of instability.

Concern for Shareholders

The payment of a dividend can also signal that the company cares for the wellbeing of shareholders. This is important if you want to a company that has your financial interests at heart. Consider: There are a number of things that the company can do with that cash. Instead of putting it into some other venture, or boosting executive pay, the company is choosing to share it with shareholders. This can be a good sign – especially if you want to be a shareholder.

Picking Dividend Stocks

As you can see, even if you aren’t choosing a stock for its dividend, looking at the dividend, and the dividend history, can help you get an overall feel for the company’s likely performance. A company that pays a dividend usually has strong fundamentals, and if the dividend has remained mostly intact through market corrections and setbacks, that is an even stronger indication that your choice is likely to offer solid returns over time. Carefully consider your options, you might find that a dividend stock makes a great investment on its own – on top of providing you with regular income.