- Investing in dividend-paying stocks is an alternative to other investments that provide income such as bonds, annuities and interest-bearing accounts. The size of dividend payments investors receive is based on the earnings of the business that issued the shares. If a business has low earnings, fewer profits will be available to distribute to investors, while periods of high profits can result in large dividend payments.
- Stocks that pay dividends allow investors to earn income in two ways: through the recurring dividend payments and the appreciation of stock value. The share prices of dividend-paying stocks fluctuate like any other stock. If you buy shares of a dividend-paying stock and they go up in value, you will earn a return on your investment as well as earning dividend payments while you hold the stock.
- Because companies that offer dividends do not reinvest all of their profits into the company, growth potential of dividend-paying stocks may be lower than stocks that don't pay dividends. Another drawback of dividends is that they are treated as normal income for tax purposes. Stock brokerage firms, mutual funds and other companies must provide investors with tax form 1099-DIV to report dividend income earned. Ordinary dividend income is taxed at your normal marginal tax rate. If your tax rate is 25 percent, you will pay 25 percent of your dividend income to taxes.
- Some corporations with shares that pay dividends offer dividend reinvestment plans. A dividend reinvestment plan uses the dividends a shareholder would normally receive to buy additional shares of stock. In other words, the investor does not receive his normal dividend payment, but he gains more shares of stock in the company. Investors might prefer to reinvest dividends if they do not have an immediate need for extra income.
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