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Everyone dreams of financial independence and passive income that grows over time. One of the more reliable methods for achieving this goal is dividend investing. The idea of receiving regular income from stock investments is enticing, but can you build significant wealth through dividends?
Dividends represent a portion of a company's profits distributed to its shareholders, typically regularly, quarterly or monthly. When you invest in a dividend-paying stock, you receive income based on the number of shares you own. Dividends are more commonly issued by mature companies with stable cash flows, often in sectors like utilities, health care, or real estate. Tech companies like Apple and Meta now offer a small dividend.
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Reinvest Your Dividends Now For Income Later
Spending that dividend income is tempting, but you will miss out over the long term. One of the key advantages of dividend investing is the ability to harness the power of compound growth. Reinvesting your dividends to purchase additional shares means your dividend payouts can increase exponentially over time.
For example, if you start with an investment of $10,000 in a company yielding 4.5% in annual dividends and reinvest those payments, your investment could grow to over $24,000 after 20 years – without factoring in any stock price appreciation. This compounding effect means that your dividend income will grow alongside your stock holdings, potentially delivering substantial returns over time.
Beyond the potential for compounding, dividend stocks offer several key benefits. Stocks that pay dividends tend to be less volatile than non-dividend stocks, which adds a layer of stability to your portfolio. During market turbulence, the income from dividends can help cushion the blow by providing steady cash flow. Although the Magnificent Seven has dominated the last several years, historical data shows that companies that pay dividends tend to outperform those that don't.
Additionally, qualified dividends are taxed at a lower rate compared to ordinary income. In 2024, the federal tax rate for qualified dividends ranges from 0% to 20%, depending on your income bracket, compared to up to 37% for regular income.
Dividends Aren't Guaranteed
Dividend investing is not without its risks. A company can reduce or suspend its dividend payments if its financial health deteriorates. For instance, companies in highly cyclical industries, like energy, may struggle during economic downturns. BP (NYSE:BP) famously slashed its dividend by 50% in 2020 after the pandemic caused a collapse in oil prices, demonstrating the risks involved. More recently, Medical Properties Trust (NYSE:MPW) cut its dividend by 47% as it wrestled with the fallout from the bankruptcy of one of its major tenants.
Diversifying your portfolio across different sectors and companies is important to mitigate these risks. Relying too heavily on a single stock or industry can lead to significant losses if that company faces challenges. Some high-yield stocks can be long-term portfolio winners. Others can be yield traps, where a company offers a high yield but that yield is rising because the stock price is dropping, and the company might be in trouble.
Don't Forget About This Key Metric
If you’re considering dividend investing, start by researching companies with a strong history of dividend payments and sustainable payout ratios. You want to see a steady track record of payments and know that the company can continue to pay at the current rate or higher.
A payout ratio, which measures the proportion of a company's earnings paid out as dividends, is critical in assessing its ability to maintain its dividend. To determine the payout ratio, divide the dividend per share by the earnings per share and then multiply by 100 to get a percentage. A payout ratio under 70% is generally considered sustainable, though this varies by industry.
Several tools and resources, including financial websites, stock screeners, and investment newsletters, are available for identifying top dividend stocks. Consulting a financial advisor can also help you tailor your investment strategy based on your goals and risk tolerance.
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Two Dividend Stocks to Watch
Let’s look at two strong dividend stocks that could offer long-term growth:
1. Altria Group (NYSE:MO): A leader in the tobacco industry, Altria has a long history of rewarding its shareholders with consistent dividend payments. As of September 2024, Altria has a dividend yield of approximately 7.55%, one of the highest in the S&P 500. Altria’s steady cash flow, driven by its established brands, makes it a popular choice among income-focused investors. The company has also managed to grow its dividend for 55 consecutive years, qualifying it as a Dividend King.
2. Johnson & Johnson (NYSE:JNJ): A diversified health care company, Johnson & Johnson is known for its stable and reliable dividend. With a current yield of around 2.9%, J&J has increased its dividend for 62 consecutive years, making it a favorite among long-term investors. J&J's strong balance sheet and presence in health care innovation help it weather economic downturns, offering a layer of safety for investors seeking income.
Alternative Income Option: Real Estate Investing
While dividend stocks are a great tool for generating passive income, they aren't the only option. Investing in real estate, particularly through platforms like Groundfloor, is another way to build wealth.
Ground floor allows you to invest in a portfolio of real estate investments, supporting individual real estate investors who are rehabbing homes. Projected returns are between 8% and 15%. With a minimum investment as low as $10, Groundfloor offers an accessible way for smaller investors to enter the real estate market.
However, like stocks, real estate carries risks, including fluctuations in property values and market conditions.
Can you get rich off dividends? The answer is yes, but it requires patience, discipline, and a long-term investment strategy. By selecting strong dividend-paying companies and reinvesting your dividends, you can grow passive income over time. Coupled with diversification and a careful assessment of risks, dividend investing can be a reliable path to financial freedom.
Ultimately, building wealth through dividends is not an overnight strategy, but the right approach can provide a solid foundation for long-term financial success.
This article Three Things To Know To Build A Dividend Portfolio For Passive Income originally appeared on Benzinga.com