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Note: This is the third story of four in a series called “Beating the Banks.” You’ll find links to the others below.
Bank savings accounts beat stuffing money under the mattress, but when it comes to interest, not by much. Depending on the type of account, you’ll be lucky to earn 1 percent. (Check out our rates search and you’ll see what I mean.)
These days you’re likely to earn more interest by owning shares in a bank than putting your savings in one. For example, Discover Bank was recently paying 0.85 percent on savings accounts. But put your money in their stock instead of their vault and at its recent price of $32, you’ll earn dividends of 1.25 percent.
What’s the difference between dividends from a stock and interest from a bank? For all practical purposes, nothing. Call it dividends, call it interest – it’s simply money you get back for putting money in.
In the video below, Money Talks News founder Stacy Johnson breaks down the basics of dividend stocks, including reasons why they’re not for everybody. But if you’re out to beat the banks, they’re definitely worth considering. Check it out, and then read on for more.
As Stacy promised in the video, you can peek at his portfolio. Every stock on there (minus the gold shares) pays dividends. As he says, his stocks aren’t recommendations, and neither are the examples in this article: The only way to decide what’s right for you is to do your own research. There’s tons of free information available online from sites we partner with, like MSN, Yahoo, and TheStreet.com. If you open an account with an online broker, that often gets you access to additional research. For example, Vanguard gives its clients free access to Standard & Poor’s stock reports.
But here’s some general info to help you understand dividend stocks.
Not all stocks pay dividends.
Companies that have a lot of room to grow (appropriately called “growth stocks”) put their profits back into their business, rather than sharing them with stockholders. Apple – currently the most valuable publicly traded company in the world – doesn’t pay dividends, although it may be approaching a point where it will because it faces the delightful problem of having more money than it can use to expand. (Of course, it’s cheaper to buy the new iPad HD than a single share of Apple.)
Dividends are usually paid quarterly.
While companies can pay dividends at whatever frequency they choose, most choose to pay their shareholders every three months. Regardless of the pay dates, when you see a dividend number as a value in dollars and cents, it’s usually the annual payout per share. So if you look at Ford and note the dividend rate is 20 cents per share, that means it pays 5 cents per share quarterly. (Ford, which didn’t get a government bailout, just resumed offering dividends for the first time since 2006.)
What’s the rate?
Divide the dividend amount by the stock price and you’ll know what you’re earning on your money. For example, AT&T: This stock pays an annual dividend of $1.26, and its recent price was $32 a share. $1.26 divided by $32 gives you a yield of 5.57 percent. (Note that the quote page for AT&T does the figuring for you. Look for “Yield” at the bottom of the “Details” column.) JP Morgan Chase has a yield of 2.69 percent and Pepsi is paying 3.2 percent.
Important: While dividends can change – hopefully they go up over time – what you earn is based on what you pay for the stock. For example, in a recent article called The Single Best Tip to Beat High Gas Prices, Stacy suggested investing in companies like ConocoPhillips to hedge high gas prices. When he first bought ConocoPhillips back in 2009, he paid $35 a share. Since this company pays $2.64 a share in dividends, Stacy is now earning 7.5 percent on his investment ($2.64 divided by $35.) But since the stock has doubled since then, buy at today’s price of $77 and you’ll only earn 3.4 percent ($2.64 divided by $77.)
You can automatically reinvest dividends.
You probably know savings accounts compound interest – in other words, they pay interest on your interest earnings. Dividends can do the same by using a dividend reinvestment plan, also known as a DRIP. Stacy’s ConocoPhillips stake serves as a good example. He bought 300 shares in 2009 and has reinvested the dividends since. Today he has 334 shares. So he’s raised his stake by 10 percent without investing another dime.
“Dividend aristocrats” raise dividends regularly.
Companies can raise, lower, or even eliminate dividends at the whim of their boards. The ideal company, of course, has a record of increasing their payouts over time. Companies that have raised dividends annually for at least 25 years in a row are recognized as “dividend aristocrats” by Standard & Poor’s. As The Street points out, “Investing in only the aristocrats has been a profitable strategy, with the group returning 5.3% last year, compared to a flat return on the broader index.”
You don’t need a bundle to get a bundle.
The fewer stocks you own, the riskier your portfolio. Even if a stock is huge and well-known, it can fall off a cliff – think GM.
If you don’t have enough money to invest in at least five individual companies, you should look into mutual funds and/or exchange-traded funds (ETFs). These are simply baskets of stocks, so rather than owning shares of a few stocks, you own a tiny sliver of dozens. There are mutual funds and ETFs specializing in all kinds of stocks, including the kind that pay high dividends. For example, here’s a description of the Vanguard Dividend Growth Fund: “The fund focuses on high-quality companies that have both the ability and the commitment to grow their dividends over time.” The minimum investment is $3,000. The same thing comes as an ETF, meaning it trades like a stock on an exchange. Its current price is around $58 a share and it’s paying 2.14 percent.
Of course, those aren’t the only options out there. To find more, do what I did: search “Dividend ETFs” or “Dividend mutual funds,” and search for opinion articles on the partner sites mentioned above.
You pay less income tax on dividends.
Providing they’re “qualified” (most U.S. companies make the cut), dividends are taxed at a lower rate than interest, at least for this year. If you’re in a 15 percent tax bracket or lower, dividends are tax-free. If you’re in a 25 percent tax bracket or higher, you’ll pay only 15 percent on your dividend income.
There’s no free lunch.
No one can claim that comparing dividend stocks to insured bank accounts is apples-to-apples. Banks are insured, stocks aren’t. Stocks can, and periodically do, go down in value, and that includes dividend stocks. So they’re not for everybody. But they could be a potential partial solution to low rates.