The Importance of Dividends on Investments
Dividends are a company’s way of sharing their profits with investors who stay put with their investments over a considerable period of time. Dividends are a reliable source of income for many investors and are offered by various instruments like bonds, stocks, mutual funds, and other securities. They also hold a special place in an investors’ portfolio for being highly tax efficient.
Dividends offer many advantages to investors and can be a useful investing method to tackle the adverse effects of inflation, market volatility, and more.
If you haven’t used this tool of investing yet, here are some benefits of dividends that will make you want to add them to your portfolio:
1. Dividends are a reliable income source
To begin with, it is important to realize the positioning of dividends in your investment portfolio and income sources. It is important to note that dividends are a stable and reliable income that investors receive without making any alterations to their investment portfolio.
Generally, a major income flows in only when you sell off your shares or stocks. But, with dividends you get an income source that comes without any variance to your portfolio. Although the companies are under no obligation to pay out dividends to investors, major companies who have been flourishing in the markets over the years do maintain a regular dividend sharing practice with their shareholders.
2. Dividends are a good growth opportunity
When you invest in dividend paying companies, you are essentially expanding your return horizons. Most of the well-established companies or market players not only stay consistent with dividend payouts to their investors but also increase the dividend percentage at regular intervals (generally once every year). Although, risk cannot completely be eliminated while investing in market-related instruments, investing in dividend paying companies can assure partial returns over investments that can be better than non-profiting investments in stocks, especially in such volatile markets.
Of course, there are exceptions, but only a few dividend paying companies have faltered over the years. The rest of them have been consistent in paying out dividends with a promising future ahead.
3. Dividends are tax-efficient
Investors can save a major chunk of their earnings from high taxes by opting for dividend options. Being a steady income source, dividends are taxed differently if managed well. The tax rates for qualified dividends range between 5% and 15%, depending upon the income range. Typically, a low-income range is taxed at a rate of 5% which is quite low as compared to the percentage of tax charged on other investments which is generally above 25%. There are several tax advantages associated with your dividend earnings unlike income from other investments.
4. Dividends allow portfolio expansion
With dividends acting as a steady side income source, investors have an excellent opportunity to expand and diversify their investment portfolio. Portfolio diversification is essential to your financial health requiring a considerable income at disposal to be invested across industries. Even if you invest the SIP way, you will still require regular money. Dividends, on the other hand, allow investors a higher level of flexibility that helps them make good investment decisions while expanding their portfolio.
Also, when you reinvest your dividends, you are creating more sources of income by acquiring more shares. You can always manage the flow of money as per your requirements since there is a provision to reinvest a partial percentage of your dividend earnings back to the investments. Moreover, investors are allowed to make a free reinvestment of their dividend earnings back to the original source.
5. Dividends help manage risk and volatility
This might come as a surprise but dividends are quite handy when it comes to managing portfolio risk and volatility. When investors suffer losses due to a fall in the stock price, dividends help balance out the loss and mitigate the risk. There have been a lot of studies indicating a better performance on the part of dividend paying companies and stocks than the non-dividend paying ones. These trends have particularly stood out during the bearish cycles of the market. Even though a bear market is generally unfavourable to all industries and investment instruments, yet dividend paying stocks have outperformed their counterparts fairly well in those times as well.
The fact has been testified during the 2002 market fiasco when the overall downturn dragged the whole economy and investment industry into a considerable low. An average 30% downfall was observed in the overall market but to everyone’s surprise, the dividend paying stocks suffered only a 10% decline reinforcing the investors’ faith in them.
6. Dividends help beat inflation
Inflation can be a hole in the pocket with the capability to eat away all your hard-earned money. While budgeting or evaluating the profit earnings, investors generally forget to factor-in inflation that later on challenges their foundational assumptions and estimates.
Dividends help investors to balance out the loss caused by inflation in order to reap any actual benefit from their investments. For instance, if you earn an average profit of 7% per year on your investments and inflation for the given year is 8%, then realistically you have incurred a loss of 1% rather than any profit. This in turn adversely affects the purchasing power of the capital.
On the other hand, if your investments offer a 7% return on investment plus a 4% dividend payout, then you have made a profit beating the rise in inflation. As a general rule, most dividend paying investments outrun the inflation affects, leaving the investor with a handful of earnings.
7. Dividends are sustainable
A person’s needs and wants grow every single day, leaving very little room for a balanced lifestyle and continual investing. Dividends act as the support system in such times promoting sustainability in income flow. With the diverse effects of inflation on the individual and the economy, one of the most reliable go-to options for a secured income is a dividend paying stock.
To sum it up
Dividends are an indispensable part of the income that is the least affected by stock movements that are sure to arise. With the market flooded with dividend kings like Proctor and Gamble, Phillip Morris International, Marks and Spencer etc, it is certain that dividends carry a strong legacy and a promising future ahead. Investing in dividend paying stocks is as vital as securing a stable income source so that the future is not jeopardized at the free will of inflation and market volatility.
In such intricate matters, looking out for expert advice is always a good idea. Reach out to financial advisors to get the best advice on your next dividend paying investment to make the maximum out of it.