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Investing for dividend income is a smart way to invest in the market and participate in the profits of successful businesses. Sure, the income from dividends might not be as tax efficient as long term capital gains, but there are many other benefits. Depending on your goals and your situation in life, a well constructed dividend income portfolio maybe something to consider.

Is Dividend Investing the Same as Income Investing?

Great question. Sure, dividends are income so all dividend investing is income investing. But income investing can be done in a variety of ways, stock dividends are only one of them. The interest or coupon payments on bonds is also one way of income investing, and so is private loans to individuals or businesses, either negotiated as a commercial note or done through online debt exchanges such as Prosper or Lending Club. Income from rental property also classifies as income investing. When you compare interest income vs. dividend income or even rental property income, keep in mind that their tax treatments can be quite different. Interest income typically earns the regular income tax rates, while dividend income may be taxed at a lower rate. The income tax laws regarding dividend income keep changing, but the tax rates are generally the same or lower than regular interest income.

You Should Consider a Dividend Portfolio if any of the Following is True

• You are retired or are close to retirement and need a regular, fairly dependable income stream to live on without having to sell your investments
• You have a full time job or a business and want to invest in unrelated businesses (diversify your income) and generate additional passive income through dividends
• You are investing for the long term and are looking for an easy way to find profitable companies to invest in. Dividend paying companies are typically better managed, and the cash flow is less likely to be misrepresented as real cash needs to be paid out to the shareholders as dividends
• You are looking to invest in DRIPs (Dividend Reinvestment Plans) either for yourself or may be to teach a child about investing using DRIPs. DRIPs allow you to bypass a traditional stock broker and their fees for the most part and invest directly with the company, and you get a real stock certificate in your name.
• You want the peace of mind that can only come when the stock you invest in shows you the real cash.

Frankly, I like dividend stocks just because they throw up cash that I can than use to make new investments. This allows me to stay fully invested in my stocks so I do not miss those precious few days of stock appreciation in any year that make all the difference between a great performance and a dismal one. Whatever your reasons may be, there are many choices available to you as you select stocks that you want to include in your dividend income portfolio.

Your Investing Choices

Depending on your income requirements, the amount of risk you want to take, as well as the level of complexity you want to handle in your taxes, you may want to integrate one or more of the following types of investments in your portfolio.

1. Stable no or little growth dividend payers: Most utility companies fall in this category. While these companies do not expect to grow much or grow their dividends much in the future, these companies have a stable customer base, predictable revenue streams and typically some sort of regulatory protection that keeps competition away. You will be rewarded with a predictable quarterly dividend stream and you can sleep better at night knowing it is unlikely that these companies will disappear overnight (Enron and Calpine were exceptions, they went way beyond what a typical staid utility companies do). They also generally pay higher dividends. 4%-6% dividend yield is not uncommon. Two examples are DTE Energy and Southern Company. Beats putting money in a CD any day.
2. Dividend growth companies: These companies have a long history of not only paying uninterrupted dividends, but they also grow their dividends every year as their business grows. Johnson and Johnson is my favorite, but of course there are many others. It is not uncommon with these companies to find after decades of ownership that the dividends you are getting now every quarter per share are actually more than the original investment in each share of these companies. In other words, you get paid back and more. If you reinvest these dividends in more shares, you actually compound your dividend income even faster. Pretty powerful!
3. REITs: Real Estate Investment Trusts, or REITs, technically do not pay dividends. The trust payments are classified more as a traditional income. Still these are structured and more liquid way of enjoying real estate/rental income without the hassle of property management, mortgage negotiations, etc. REIT income yield can be high, but depending on what the REIT invests in, you may be on a riskier territory. If you want to go this route, make sure you understand what the REIT is investing in. For example, a REIT that invests in hospitals and medical offices maybe safer than a REIT that invests in developing Florida marshlands for baby boomer retirees.
4. Royalty Trusts and Master Limited Partnerships: These are less understood but can be highly lucrative. Royalty trusts and MLPs also in the strict sense of the word do not pay dividends. Due to their corporate structure, they pay out a distribution to their unit holders. This distribution is directly linked to the profits in the business they are involved in, as profits technically flow through to the unit holder. As a unit holder, you are considered as a partner in the business, which means that you will receive a partnership K1 form for completing your taxes, which might get quite involved. You will definitely want to get a competent CPA for your taxes. Understand that many CPAs are also not properly educated on how these entities work. The yields can be very high and as a flow through entity, accounting expenses such as depreciation or resource depletion can be used to offset your income tax liability. The risk with US based Royalty trusts are that they will eventually dissolve. They are not allowed to raise new capital or fund growth so as the wells or mines are depleted, so is the income. An alternative is to invest in Canadian trusts (also called CanRoys) that have no such restrictions.

Most of the companies pay dividends on a quarterly basis. There are a few companies that pay annual or semi-annual dividends. REITs, MLPs and Royalty Trusts are your best bets if you are looking for monthly dividend income. Alternatively, you can structure a portfolio of quarterly dividend paying stocks whose dividend schedule fall on successive months. This way you are sure that you will be earning predictable income every month.

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Dividend Income Investing – Constructing a Dividend Income Stock Portfolio

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5. Investing Money in the Stock Market – What You Need to Know

Source: sxc.hu Photo: soopahtoe

Forget about home ownership and from your own bootstraps success stories; my husband maintains that the American Dream is “earning more while working less.” And, in a way, he is right. Many people do believe that they have it made if they can earn money while doing practically nothing. And I guess you do. This type of income – income that comes even though you don’t really do anything – is known as passive income. And it can be a real help when it comes to improving your cash flow.

What is passive income?

Let’s look at a quick working definition. According to the IRS, passive income comes from “trade or business activities in which you do not materially participate.” This type of income comes from a sort of set it and forget it kind of place. You do not have to actively work to keep the money flowing, yet it still does, regular as clockwork. Some examples include:

• Property rental income.
• Business earnings from ventures that do not require your direct involvement.
• Royalties from patent licenses, intellectual property or book publishing.
• Residual income. (This is regular income that comes as a result of ongoing payments. For example, if you sell insurance, you might receive continued income every time your clients make their premium payments.)
• Earnings from online resources, such as advertising on your Web site, or affiliate and referral earnings.

For our purposes, we will also include returns you receive in interest and dividends from stocks and/or bonds. The IRS considers these to be what is called portfolio income, but these are passive in nature, and it does provide you with regular cash inflow without your ongoing involvement.

Is this cash flow really passive?

One of the more interesting questions with regard to this type cash flow is whether or not it is truly passive. From the standpoint that you might not be doing anything active to “earn” it right now, it could certainly be considered passive. But if you look at it from the perspective of the original attempts at earning it, you might discover that it is not all sitting around and doing nothing.

Indeed, most people had to do something quite active in order to set things up. If you are reaping the benefits now, it usually means that you put in some hard work up front. It takes some time and effort to set up a Web site that attracts enough traffic to generate the ad revenues you might have. Looking for good dividend investments for your income investing needs can be time consuming and requires a great deal of research and mental labor. You can’t collect royalties on a book unless you have first worked to write it.

Just about every form of passive income is preceded by some kind of active work. This means that in order to enjoy rewards later, you have to put in the effort now. But if you are smart about it, and careful, you can create earnings  streams that will last you a life time, improving your cash flow and diversifying your earnings in such a way as to help protect you against the realities of job loss and recession.

Warnings You Should Heed

Passive income can truly provide you with a number of helpful advantages in terms of money. However, it is important to be careful, and to make sure that your actions are rooted in reality. Here are some things you should consider:

1. Adjustments may be necessary. Especially in the case of dividend and income investing, it may be necessary to make adjustments. Business earnings and Internet earnings may require additional attention and tweaking. Just because your  earning is supposed to be hands off, it doesn’t mean that you won’t ever have to touch the sources again. Especially during times of recession you may need to make changes in your spending, and adjust your earning streams and/or portfolio.
2. Watch out for scams. Because of it’s popularity, and the idea of earning money from home is so desirable, scams are becoming prevalent. It is important to carefully screen all such “opportunities” that you may come across. Remember: If it sounds too good to be true, it probably is. Setting up such businesses usually requires more work than ordering a special kit to “automate” your earnings. You’ll need to do that on your own.
3. Passive income can be lost. Just because you have it set up now, and it has been coming in regularly doesn’t mean that your  earnings will remain at the same level. Dividends are cut. Books stop selling as well. Your Web site loses traffic. Keep in mind that you still need to make a plan for your money, and that you should not rely too heavily only on one or two income streams. Make sure your earnings are sufficiently diversified to absorb dramatic changes in your businesses.
4. Don’t forget your estimated taxes. Since taxes on passive income are not withheld at source, as they are from your paycheck, make sure you figure out your quarterly tax payments to avoid penalties from the IRS or your government taxing authority. You should work with your tax professional to determine your quarterly tax payments.

In the end, passive income can be a great tool. But you have to use it carefully, or you might find yourself with dwindling returns and nothing to fall back on.

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Improving Cash Flow with Passive Income

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2. Dividend Investing for Passive Income and Portfolio Growth
3. Dividend Income Investing – Constructing a Dividend Income Stock Portfolio
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5. Are Higher Capital Gains and Dividends Taxes Coming?

Photo: David Niblack

Among the buzzwords you hear a great deal when you read about finance and investing is “passive income.” One way that you can earn money in a regular income stream, passively, is to invest in dividend paying companies. These are companies that regularly pay out a portion of their profits to shareholders, called dividends. “Dividend” is derived from the Latin “dividendum”, which indicates something that is divided. In truth, in ancient times it probably meant spoils of war or portions of some trade venture parceled out to participants. Today, many companies keep a portion of their profits (referred to as retained earnings), and if there is anything left over, it is divvied up and distributed amongst shareholders according to how much equity they have.

Dividends are paid monthly, quarterly, semi-annually or yearly. A special dividend may be issued at any time, if a company feels it is warranted. This is in addition to a regular dividend. While normally paid in cash, it is possible for dividends to be settled as store credits (if the investment is in a retail consumer cooperative) or as shares in the company (these are either bought on the market or created new). When you hold shares in a dividend paying company, you can receive regular cash payments without doing anything other than hold the stock.

Dividend Investing with Dividend Reinvestment Plans (DRIPs)

One of the most popular ways to take advantage of dividend paying companies is to invest using dividend reinvestment plans. Instead of receiving a regular cash payment, your dividend is used to automatically buy more shares in the company. It is like receiving free shares. You do not have to actively buy them, and in many cases you avoid the transaction fees that come with making purchases of additional shares. DRIPs can be a way to help grow your investment portfolio for the future. It is a plan that delays the gratification of receiving cash until a later date. You don’t get the cash as part of a regular income stream, but you do end up with a larger portfolio. If the company’s stock does well, a DRIP can lead to higher returns overall.

Many companies offer DRIPs to stock holders. In fact that there are more than 1,000 dividend paying companies, and a large portion of them offer DRIPs. Most banks and other financial institutions pay dividends, and many offers DRIPs. Some other companies that offer DRIPs include:

1. General Electric (GE)
2. Kraft Foods (KFT)
3. AFLAC (AFL)
4. Allstate (ALL)
5. Merck (MRK)
6. Marriott International (MAR)
7. Exxon (XOM)
8. IBM (IBM)
9. Intel (INTC)
10. Verizon (VZ)
11. UPS (UPS)
12. Wendy’s (WEN)
13. Hershey (HSY)
14. Waste Management (WMI)

It is important to understand that DRIPs often come with requirements. Some companies require that you own a minimum amount of shares before participating in a DRIP. Others insist that shares in the company be held in your own name, rather than in the name of a brokerage. There may also be restrictions on when you can sell your shares if that need arises. Before you invest, you should understand the requirements expected by the companies. You should also be comfortable with owning fractional shares.

DRIPs encourage good investing habits

Another often overlooked advantage of owning a stock through DRIPs is that it forces your portfolio to do ‘dollar cost averaging‘. This is a method of investing where same amount of cash is invested each period to buy additional shares. When the stock price is high, less number of shares will be bought and when the stock price is low, more number of shares will be bought. This has an effect of keeping the cost basis of the shares low.

Even if you chose to do your investments through a broker (keeping your shares in street name as opposed to taking a stock certificate), you may still be able to set up a dividend reinvestment program. Many brokers today offer an option to reinvest your dividends in additional shares as the dividends are received. Most such offerings are complementary, meaning you will not be charged additional transaction fees or commissions. If you would like to know more about this, please check with your stock broker.

Dividends in funds

It is possible to include dividend paying stocks in funds. Mutual funds and ETFs often include dividend paying stocks. The advantage of owning funds that focus on dividend paying stocks is that your dividends could be more frequent and uniform than if you had owned a few stocks directly. This is because the funds can be more diversified than a individual portfolio can be and while it may own a few stocks that pay semi-annual dividends, it probably also owns many other stocks that pay quarterly or even monthly dividends. You should realize that, even if your fund is tax advantaged, you may have tax obligations on the dividends you earn.

Dividend paying stocks can be of great benefit to you, whether you choose to use them as a source of passive income immediately, or whether you decide to use DRIPs to grow your portfolio for the future. However, it should be remembered that dividends can be cut. In these economic times, many companies have slashed their dividends in order to reduce costs. You should understand that, just like any other investment, there is the risk that the returns will not always be as high as you would like.

Photo: David Niblack

Post from: Personal Dividends. Subscribe to the original site Feed

Dividend Investing for Passive Income and Portfolio Growth

Related posts:

1. Dividend Income Investing – Constructing a Dividend Income Stock Portfolio
2. What is Income Investing?
3. Investing in Bonds for Portfolio Security and Modest Growth
4. Improving Cash Flow with Passive Income
5. DRIP Investing for Kids