Passive Income:  Invest for Dividend Income

3 Reasons I Invest for Dividend Income

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I’ve always loved dividends. When it comes to earning an income what can be better than little bundles of money arriving in my bank account with very little effort on my part?  Not much.  And if you’ve done your research, the stock you invest in may even go up in value.

Up until a couple of years ago, I had a portfolio of dividend income stocks that generated an average of $600 per month in passive income.  That portfolio was sold to buy a house – a decision I don’t regret.  But I have missed the income that arrived mostly on autopilot.

So this year, my goal is to get my dividend income back up to an average of $200 per month. As you can see from my income reports, some months I’m getting close to that, and others, well not so much. This is partly because I’ve been sitting on the sidelines and just collecting dividends from the stock positions I already hold.

That changed in June, 2012 when I made my first (small) stock purchase in 6 months.  I purchased the stock on June 6, 2012 and as at the time of writing the stock has hit a new 52 week high twice and raised its dividend.

This one purchase has reminded me why I like investing for dividend income so much. I’d like to share just 3 of those reasons:

1.     Dividend Investing is Boring

I have heard investing for dividend income described as boring.  If you’re investing in stocks that have a proven record of continually paying and increasing dividends over the long term, I would agree.  But that’s the kind of boring I like!

Unlike investing, or speculating, for capital gains, you are not constantly watching the market for an exit to lock in your gains.  That is usually where the thrill in trading the stock market comes in.  When you sell and lock in your profit.

Investing for dividend income, however, is more about buying an income stream; a regular mostly passive income stream to supplement, or even replace, your earned (read job) income.

And if that is your goal, you want dividend investing to be predictable – and boring!

2.     Dividends Increase Over Time

Investing for dividend income is often compared to the less risky investing for fixed interest income.  The assumption being that investing for fixed interest through certificates of deposit (CD’s), high yield internet savings accounts (such as ING Direct) or term deposits is less risky because you cannot lose your capital (the amount you invest).

As a result, investing for dividend income will generally give you a greater yield than the APY (annual percentage yield) you will get on your CD’s or other fixed interest investments.

That is usually where the analysis stops.  But there is another element to the difference between investing in fixed interest income and investing for dividend income.

Not only is the yield on most dividend paying stocks higher than the fixed interest APY (annual percentage yield) or interest rate. But dividends will often increase over time, if you buy the right stocks, even during periods when the interest rate on bank deposits falls.

For example: 

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If you buy 100 shares of a $10 stock, you have invested $1000.  The dividend payable on the stock when you buy is 50 cents per share or 5%.

100 shares x 50 cents = $50 in dividends

$50 divided by your $1000 investment = 5%

The following year the company you invested in raises dividends to 60 cents per share.  Your new yield (over your cost price) is 6%

100 shares x 60 cents = $60 in dividends

$60 divided by you initial $1000 investment = 6%

If you chose the right stocks, this will continue over time and your yield will increase, generally to a rate well above the interest rate offered on bank deposits.

3.     Dividend Investments can have Favorable Tax Benefits

Income from dividends also often receives favorable tax treatment.  This means you keep a bigger proportion of the dividend income you earn than any the income you earn at your job.

The exact details of the tax treatment of your dividend income will depend on the country in which you are investing, but the US and Australia have had favorable tax treatment on dividends for a number of years.

Franking Credits in Australia

In Australia, company dividends can be paid with a franking credit.  A franking credit is an amount equivalent to the company tax already paid on that dividend.  The logic is that dividends are a distribution of company profits to shareholders, who are the owners of the company.  If that distribution is made from after tax company profits, the tax credit associated with that profit is passed on to the shareholder as a tax credit when they receive their dividend.

This can get a little complicated because the benefit to the shareholder depends on the company tax rate and the individuals tax rate, but bottom line you get to report a tax credit.

Qualified Dividends in the USA

Since 2003 qualified dividends paid by US companies to shareholders came with a concessional tax rate equivalent to the long term capital gains rate rather than the ordinary income rate of the tax payer.

At the time of writing, July 2012, the tax rate on qualified dividends for taxpayers in the 0- 15% tax bracket is 0% and for all other taxpayers (25% – 35%) tax brackets qualified dividends are taxed at 15%.

But before you rush out and invest in qualified dividend paying stocks in the US, you should know the discounted tax rate provisions are due to sunset at the end of 2012.  They have been extended once before in 2010, but I have seen nothing, yet, to indicate it will happen again.

These are the big three reasons I love to invest in stocks for dividend income.  Do you invest in dividend paying stocks for income?  Please share your thoughts and experiences in the comments section below!

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