I love dividends, it’s like free money. Below I’ll highlight 3 reasons dividend-paying stocks work for me. Let me know if you agree.

What Are Dividends?

A dividend is a small portion of a company’s profits that gets paid to shareholders (usually quarterly).

The amount of dividends you receive is based off the number of shares you own. So if a company is paying 10 cents a share that quarter, you can multiply .10 by the number of shares you own in the company to get the amount you’d receive that quarter.

For example, let’s say company XYZ pays 10 cents per share every quarter, and you own 20 shares in that company, you get 2 dollars. Obviously no one is going to be retiring on that amount. But over time as you acquire more shares and let the payments compound and grow, you can establish a source of extra income.

#1 – Companies That Pay Dividends Are Often In A More Established/Stable Business Phase.

A company that pays dividends is giving the shareholder a piece of the the profits made. New companies and companies in a growth phase are less likely to pay dividends so they can use that money to further develop and grow the business. Instead they invest that money back into the company for new equipment, facilities, research and development, larger staff, etc.

On the other hand, older companies that are more mature and established in their product and process can reward shareholders with dividends. They know what their products are and how to sell them. Of course, any company is constantly under pressure to maintain it’s profits and adapt to a changing world. But in general, more mature companies have a stability that allows them to share their profits. That stability can be a good thing for the investor and a factor to consider for less risky investing.

Some people prefer to invest in new companies that are just starting, hoping for large profits if it’s successful. Other people like to invest in solid, well-established businesses that have been around for decades and know how to continually create profit. Some people look for a blend of both. There are all kinds of investing strategies to consider and research and see what works for you.

Do dividend-paying companies deserve a place in your portfolio?

#2 – Qualified Dividends (In America) Are Taxed At A Lower Rate Than Wages From A Job

You can make an income in a lot of ways. One of my favorite ones is to wake up to an email that says a company’s dividend payment was deposited into my account. The only thing better than that, is knowing that it gets taxed at a lower rate than the income I get from working as an employee. Isn’t that crazy? It’s like getting free money and keeping more of it.

The more you can shift your income over to investments and make money from those investments, the less you’ll have to work AND the less you’ll have to pay in taxes compared to if you were working for that money.

There is an important disclaimer to this though. There are two types of dividends, ordinary and qualified. Be sure to check which one you’d be getting before buying stock in that company. Qualified dividends are taxed at a lower rate. Ordinary dividends do not receive the same beneficial tax treatment.

Building up investment income takes time, but it’s well worth it.

#3 – Letting Your Dividend Payments Grow And Compound Is A Great Way To Generate Wealth

You may choose to take your dividends and spend them. But, if you automatically reinvest your dividends, and put them back into the company and let it grow year after year, compounding can create some serious results. (Check out DRIP investing for more info.)

Every time you reinvest your dividends and buy more shares, the number of shares you own goes up. That means next quarter you’ll receive a higher dividend payment as it’s based on the number of shares you own (unless the company lowers or cuts it’s dividend, which can happen). It’s a fun process to watch.

Compounding dividends combined with the fact that companies could raise their dividend amount over time or that the stock price will fluctuate means you’ll gradually acquire more and more shares resulting in larger and larger dividends payments…like a snowball. Dividend compounding is a glorious thing.

Those are 3 reasons I consider dividend stocks to be valuable.
Dividends can reflect a more stable business.
Dividends can be taxed at a lower rate than employment wages.
Compound dividend growth is a great way to grow wealth over long term periods.

What’s your investing strategy? Do you make room for dividend stocks in your portfolio? Leave a comment with any thoughts or ideas you have.