Investors may find dividend-paying stocks or funds to be intriguing and wonder if they make sense for their portfolio. Dividends may represent an additional income stream that can help supplement stock returns.
What is a Dividend-Focused Strategy?
A dividend is a distribution to a company’s shareholders, typically in the form of a cash payout. The difference between a dividend-focused strategy and a total stock market investing strategy is the types of stocks purchased. A dividend-focused strategy primarily invests in stocks that pay a higher-than-average dividend.
These companies tend to be more stable and mature but may not grow as quickly, meaning that both share price appreciation and volatility will be lower. By contrast, a total stock market strategy will include a blend of characteristics, including both dividends and capital appreciation.
Benefits of Dividend-Focused Strategies
An investor may choose a dividend-focused strategy because it provides steadier cash flow. This may be beneficial for retirees who rely on their portfolio to supplement their income, as dividends generate cash flow to withdraw. Another benefit is that an announced dividend payment signals financial strength, profitability, and management confidence in future earnings, which may lead to lower volatility and a smoother ride.
However, this is not always the case. During the COVID-19 pandemic, some dividend funds had greater drawdowns than the broad market. This is because dividends are not static and can change. Companies can cut their dividends in tough times, and their stock price can be punished as a result.
Drawbacks of Dividend-Focused Strategies
One drawback is that dividend payments are taxable. When a stock pays a dividend, the investor must pay taxes in the year incurred, regardless of whether the dividend is taken or reinvested. Dividends can either be classified as ordinary or qualified. Ordinary dividends are taxed at ordinary income rates, while qualified dividends are taxed at lower, long-term capital gains rates.
Original reporting: Springfield Daily Citizen — read the source article.
