There are tons of articles on the internet extolling the virtues of passive income. So we’re going to show you how passive income dividends work.
But if you look closely, a frightening number of them aren’t really passive sources of income. Of course, they usually generate a steady income while you’re busy doing other things, but you’ll need to make at least some effort to make that happen.
It’s true that once up and running and producing a steady cash flow, it can generate enormous revenue. But it takes a lot of work to build your blog to this point. And even after that, you still need to manage it. At best, it’s a semi-passive income. It’s an excellent source of income, mind you, but it’s not really passive.
That’s why dividend income is an excellent option as it is a perfect source of passive income.
What makes dividends a perfect source of passive income?
Let’s start with a definition of passive income that we all agree on, income that is generated without any action on the part of the recipient. According to this definition, there are some investments that qualify. Interest-earning investments such as certificates of deposit and US Treasury bonds are certainly an example. You get stable, predictable interest income on your investment. The only problem is that most of these titles are yielding well below 1%.
Real estate rental is another form of passive income, but like blogs, it’s really semi-passive. After all, to obtain the monthly income, it is necessary to manage the property. However, dividend income is in a class of its own, especially during times of incredibly low interest rates. Without their intervention, you can create a stock portfolio that offers steady returns of 3-4% per year.
This is the best example of a truly passive investment that exists right now. Of course, it takes a lot of capital to get the income you want. But once you do that, you can start making generous income – up to $1,000 a month in dividends. And when it works, you don’t have to lift a finger to make it happen.
Main benefit of stocks with high dividends: valued capital
In this guide, I will focus primarily on dividend income, but dividend stocks also have the potential to drive capital appreciation. After all, it’s stocks, and they tend to appreciate in the long run.
Take Pepsi (PEP) as an example. The stock currently pays a dividend of just under 3% per year. The current share price is around $143. But you could have bought the shares for less than $65 10 years earlier. This means that the value of the shares has more than doubled in 10 years – while generating 3% a year of fully passive income.
This points to the double-edged advantage of dividend stocks – they not only offer stable income, but capital appreciation as well. This will protect your investment from inflation, but it will also keep it growing in the long run. This makes dividend stocks one of the best investments you can have and a highly recommended foundation for your entire portfolio. You can keep other investments, but dividend stocks must represent a significant share.
Dividend Stocks and Growth Stocks: What are the Differences?
Now I have to make an important distinction here with regard to appreciation. Dividend stocks typically do not increase in price as much as growth stocks. Because – as the name suggests – growth campaigns are all about growth. They pay little or no dividends. Instead, all profits are reinvested in the business to increase sales and profits.
Some of the best performing stocks over the past decade have been growth stocks that don’t pay dividends. A good example is Amazon (AMZN). It doesn’t pay dividends, but its stock price has risen from $170 a share ten years ago to well over $3,000.
So if you are looking for passive income, dividend stocks are the better choice between the two. Even if you want to keep several of these stocks in your portfolio, remember that you won’t make any profit on them until the day of sale. Here you benefit from an estimated value. Until then, they are only earned on paper.
Another Benefit of High Dividend Stocks: Easy Income Tax Treatment
Not only do stocks that pay dividends offer much higher income than interest-earning bonds, they also offer certain tax benefits. Ordinary dividends are taxable as ordinary income for federal tax purposes. However, qualifying dividends benefit from the lower tax rate on long-term capital gains.
To be a qualifying dividend, the shares must be issued by a US or foreign corporation whose shares are traded on a US stock exchange. You must also own the shares for at least 60 days for dividends paid on the shares to be considered eligible. Obviously, reduced (or non-existent) tax rates don’t make a difference when you keep your dividends in a qualified tax-deferred retirement plan. However, they are of great benefit if you keep them in a taxable investment account.
Where can I find dividends stocks?
Dividend stocks, at least those that yield consistently higher returns over many years, are typically issued by large companies with well-established financial histories. In most cases they are also known. This is because they have popular products or services or have long been industry leaders. And because of all of these qualities – in addition to their dividends – they are obviously popular with investors.
There are three basic ways to invest in dividend stocks, which are:
- individual actions
The current average return on all stocks in the S&P 500 Index is 1.80%. You can start by focusing on stocks with even higher dividend yields. You can certainly use stock valuation software to find these companies, but there is an easier way. There is a list of high dividend payouts known as Dividend Aristocrats, where you can find some of the best and most stable candidates. There are currently 65 companies on the list.
But just because a stock is a dividend aristocrat doesn’t make it a good investment. You should be aware that just because a company is on the list does not mean that it is permanent. For most years, new companies have been added to the list, while others have been removed.
- ETFs
If you don’t want to hold individual stocks, you can invest in ETFs. There are ETFs that specialize in dividend stocks. Did you notice that these three funds not only offer current returns that are much higher than interest-earning investments, but they also have double-digit total returns over the past decade? These funds may not make you as rich as high-growth stocks, but they do offer steady and reliable returns. If you are a long-term investor, this type of investment should dominate your portfolio.
- real estate funds
m REIT is like a mutual fund that invests in real estate instead of stocks, but not in any property. REITs invest primarily in commercial real estate, including office buildings, retail space, warehouses, large apartment complexes and similar properties. In addition, they are legally required to distribute at least 90% of their profits to shareholders in the form of dividends. This is made up of a mixture of net rental income and capital appreciation distributions from the properties sold. And for simplicity, REITs typically pay dividends on a monthly basis.
Note, however, that the long-term performance of REITs has not been good in recent years. Both Brookfield Property REIT and Kimco Realty Corp have seen significant price declines over the past 10 years, despite consistent high dividend payouts. Brandywine Realty Trust fared better in capital appreciation and has remained stable for the past 10 years.
How to Build a Portfolio to Have a Stable Monthly Income
If you want to receive monthly dividends, you need to build your portfolio with a mix of companies that pay their dividends in different months in the same quarter. The fact is, companies pay dividends quarterly. The only exception is REITs; they pay dividends monthly. But, given the poor long-term price development, you certainly don’t want a portfolio that is filled with just REITs. This would also expose you to a portfolio 100% invested in commercial real estate. Coming back to company stock, you want to defer dividend payout dates for monthly income.
For example, using stocks from the example table above, Cardinal Health pays dividends in January, April, July and October. General Dynamics pays its dividends in February, May, August and November. After all, AFLAC pays its dividends in March, June, September and December.
There is no need to distribute company dividend payments across the entire portfolio. You only want to do this if you absolutely need a monthly income. However, as each company pays different dividends, it will be very difficult to find a stock combination that generates exactly $1,000 in sales each month. It is possible, however.
The alternative is to ignore the payment dates, transfer each quarter’s dividends to a cash account, and pay a monthly average of the quarterly total.
Conclusion
Dividend stocks are not as glamorous as growth stocks. But they’re the kind of investments that build lasting wealth and the kind of income you can make if you’re doing absolutely nothing. Who doesn’t want that return? Dividend stocks are particularly attractive to retirement portfolios. They not only provide a reliable way to accumulate wealth over decades, but they also ensure a steady stream of income into retirement age. You can use the 3%-4% of dividend income to live on as stock prices increase in value over time.
Of course, this requires a much larger portfolio. But if you want to get rich or retire with a seven-figure wallet, you can also make a generous income out of it.
