When Investing Pays Dividends

Typically, stocks that pay a portion of earnings to shareholders in the form of dividends are not considered to be superstars of the stock market. They typically do not offer the growth or price appreciation potential of small-cap companies, but tend to be more stable.

Dividends may not only help provide income but could also point the way toward possible investment opportunities. Aside from the potential for steady payments, dividends can be a good way to assess a company’s health, quality of earnings, and future prospects. In fact, research shows that companies that have started or consistently increased dividend payouts since 1972 have outperformed the broader market.¹

Companies that pay dividends tend to be large and well established, and their stock may be appropriate in a conservatively allocated portfolio. Companies may elect to pay a dividend because they consider it to be a better option for distributing profits than reinvesting in the business.

Even though income stocks are theoretically less risky than growth stocks, the return and principal value of all stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.

The Uncertainty of Taxes

Under current law, qualified dividends are taxed at a maximum rate of 15%. For taxpayers in the two lowest federal income tax brackets (10% and 15%), the tax rate on dividends is zero.

However, these low tax rates are set to expire on December 31, 2010, unless Congress acts to extend them. If the special tax treatment is allowed to expire, dividend income taxation will revert to the rules that were in effect prior to 2003. Under these rules, dividend income is taxed at the same rates as ordinary income, which could be as high as 39.6%.

The possibility of higher dividend tax rates in 2011 is a factor to consider when investing in dividend-paying stocks. It would be wise to consult with a tax professional before taking any specific action.

Income stocks can offer a steady payout as well as the possibility of solid returns. Call today to discuss the role that income stocks can play in your portfolio.

1) CNNMoney, November 9, 2009

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.