Dividends are cash payments that companies make to shareholders. They can become a powerful source of passive income—but there are traps to avoid.
What Are Dividends?
When a company makes profits, it can:
- Reinvest in the business
- Pay shareholders (dividends)
- Buy back stock
Dividends are your share of the profits, paid quarterly (usually).
Key Terms
| Term | Meaning |
|---|---|
| Dividend yield | Annual dividend ÷ stock price |
| Dividend per share | $ paid per share you own |
| Payout ratio | % of profits paid as dividends |
| Ex-dividend date | Buy before this to get the dividend |
| Dividend growth rate | How fast dividends increase yearly |
Real Example
Stock price: $100 Annual dividend: $3 Dividend yield: 3% Own 100 shares = $300/year in dividends
Dividend Investing Strategies
Strategy 1: High Yield
Buy stocks/funds with high current yield (4-8%)
- More income now
- Often slower growth
- Can be "value traps"
Strategy 2: Dividend Growth
Buy companies that grow dividends consistently (10-15%/year)
- Lower yield now (1-3%)
- Higher yield on your original investment over time
- Often better total returns
Pro Tip
Dividend growth often beats high yield. A 2% yield growing 10%/year becomes 5% yield on your original investment in 10 years.
Dividend Aristocrats
Companies that have raised dividends for 25+ consecutive years:
- Johnson & Johnson
- Procter & Gamble
- Coca-Cola
- 3M
- Many more
These are battle-tested dividend payers.
The Power of Dividend Reinvestment
DRIP (Dividend Reinvestment Plan): Automatically use dividends to buy more shares.
| Initial Investment | Yield | Without DRIP (20 yrs) | With DRIP (20 yrs) |
|---|---|---|---|
| $10,000 | 3% | $10,000 + $6,000 dividends | $18,000 portfolio |
| $10,000 | 3% + 5% growth | More complex | $40,000+ portfolio |
Do This
If you don't need the income now, reinvest dividends. The compounding is powerful.
Dividend Traps to Avoid
Watch Out
High yields can be danger signs:
A 10% yield might mean:
- Stock price crashed (yield went up because price went down)
- Dividend isn't sustainable
- Company is in trouble
Always ask WHY the yield is high.
Red flags:
- Payout ratio over 80% (not sustainable)
- Dividend didn't grow in 5+ years
- Declining earnings
- High debt levels
Dividend ETFs
Easier than picking individual stocks:
| [[ETF]] | Focus | Yield |
|---|---|---|
| VYM | High dividend yield | ~3% |
| SCHD | Dividend growth | ~3.5% |
| VIG | Dividend appreciation | ~2% |
| NOBL | Dividend aristocrats | ~2.5% |
Taxes on Dividends
| Type | Tax Rate |
|---|---|
| Qualified dividends | 0-20% (capital gains rates) |
| Non-qualified dividends | Ordinary income rates |
Most US stock dividends are qualified if held 60+ days.
Pro Tip
Hold dividend investments in tax-advantaged accounts (401k, ) when possible to avoid annual taxes.
Quick Win
Check if your brokerage offers DRIP (dividend reinvestment). Turn it on for long-term holdings to maximize compounding.