The most popular earning model across the board is this; exchanging time or labor for cash. With this system, usually, the amount of money you can earn is proportional to how much effort you can put in. That’s active income and it requires continuous and upfront work. It’s money you earn from a job or contract work.

However, the simple truth is that the traditional 9-5 is no longer the ideal it used to be. Very few if any individuals ever achieve financial freedom or even stability working a full-time job. Let’s paint a picture together.

You go to work daily, clock in your hours, deliver your quota, and get a paycheck at the end of each month. It keeps your head above water but you can’t deny that you need more. The cost of living keeps rising and the economy is far from easy to navigate nowadays, especially with only one source of income.

If you’re in this situation, a low-effort stream of income is a great way to supplement your earnings without having to quit your everyday job. You can make money in real time even when you’re asleep. 

And what about freedom? Conventional jobs typically come with a pretty rigid schedule leaving a lot of folks wishing their time wasn’t so locked in. Do you relate to either of the scenarios depicted above? Then keep reading.

Passive Income | A Rundown

Passive income grants you a life where the hours you work don’t determine the amount of money you make. With passive income, you can make money while inputting as little time and effort as possible. It’s a stream of income that doesn’t come with strings (regular and active participation) attached. It’s like a job that doesn’t require a worker, someone to hit keys, draft and file reports, execute projects etcetera. 

The actual modus operandi varies depending on the type of passive income you settle on. However, generally, the greatest task attached to any form of passive income is setting up the system initially. From then on, your income stream is practically self-sustaining allowing you to generate money almost like an afterthought – you know, passively.

This article provides a detailed guide to earning passively via dividend stocks whether your goal is to supplement or completely displace your existing income. We’ll start at the very beginning;

What Are Dividend Stocks?

Dividend stocks are essentially stocks that pay out dividends. A dividend stock is a type of investment where a publicly traded company allots part of its profits to shareholders. These distributed profits are called dividends. It’s like this, imagine you’re a shareholder in a company. If you own dividend stocks, you’re entitled to a regular payout from the company’s total earnings. These payments (dividends) could come each month, each quarter, biannually, or even annually. 

How Dividend Stocks Operate

Dividend programs aren’t a one-size-fits-all sort of shtick. Companies vary, from the frequency of payments to the amount you receive. So the amount you earn with one company depends on the company. Who makes the decision you may ask? Usually, a board of directors lays down the law. They must jointly agree to set up a dividend program and also decide what percentage or portion of the company’s profits will be paid out. 

Dividend payments aren’t always cash. As a shareholder, you could earn stock dividends and additional shares of the stock you own. This makes for a pretty sweet deal because dividend payments usually come per share unit so the more stock you own, the higher your payout. Through this, you can increase your investment in the company without active involvement or financial commitment. 

Dividend Reinvestment Programs (DRIPs) could also be on the table along with special dividends which are extra, one-time payouts shareholders may get when a company is swimming in profits and would like to reward and perhaps incentivize investors.

How To Invest Dividend Stocks

It’s a lot like investing in other types of stocks. All you have to do is purchase shares in a company of your choosing. We will go more in-depth into how exactly to buy dividend-paying stocks a bit later.

Strategies For Investing In Dividend Stocks

You can go with a high-yield dividend stock or opt for a growth investment. Let’s break these classifications down further;

High-Yield Dividend Stocks

This approach focuses on the quantity of a company’s dividend payout weighed against the price of its stock. Higher yields mean a larger dividend, so the greater the yield the more money you make. However, that’s not always a sign from the universe that you should invest.  If a company’s stock performs poorly, the dividend yield increases (because it’s relative to the stock price), and that can be misleading. Let’s illustrate with an example.

Say each unit of a company’s stock cost $40 and the quarterly dividend per share was $2.5, the dividend yield would be as follows;

($2.5 / $40) * 100 = 6.25%

If its stock price dropped to $25 the new dividend yield would then become  

($2.5 / $25) * 100 = 10%

The high yield makes it seem like an attractive investment but if it’s accompanied by a drop in the stock, it may point to other issues with the company.  Better to steer clear in such a situation. If you’re interested in high yields, first confirm the stability of the stock price.

Dividend-Growth Stocks

The term “dividend growth” describes a gradual increase in a company’s payout. Investors who take the route of dividend growth stocks are concerned with whether there’s a history of raising the dividend payout for a particular stock. They’re on the lookout for consistent, consecutive increments in the history of a stock. Taken individually, the payouts per year may be on the low side, however, the promise of growth makes the dividend stock appealing as a long-term investment.

Steps To Invest In Dividend Stocks

Now to get down to brass tacks. Want to kick off your journey to earn passive income through dividend stocks? Here are the steps to take;

Step 1: Open an Investment Account

You’ll need a brokerage account which is an investment account you can use to buy stocks, bonds, and other kinds of investments. It’s an easy process you can carry out online and you don’t have to worry about making an initial deposit.

When you’re ready to purchase your dividend stocks, you can just make a bank transfer, a wire transfer, or even send cash from an existing brokerage account to fund your new account so you can make the purchase.

Most accounts require you to put down some of your personal details such as your name, house address, email address, birthday, some form of government identification, and your Social Security number.

Here are a few brokerage accounts that we recommend where you can buy dividend-paying stocks:

1. Robinhood
2. Fidelity
3. Webull

Step 2: Decide What Kind of Stocks to Purchase

With a brokerage account comes the power to own investments of your choice. This power comes with strings, that is, the responsibility of choosing the right stocks to invest in. There are two main paths open to you in this regard; dividend stocks and dividend funds. 

We already took a look at what dividend stocks are, these are companies you can buy into that pay dividends to their shareholders. Dividend funds on the other hand are mutual funds or ETFs that hold a selection of several dividend stocks. With dividend funds, your investment is spread across several different companies and this helps cushion your income should one company perform badly. 

Again you have options when it comes to funds, there are high-yield funds that focus on curating a collection of high-paying dividend funds. Dividend appreciation funds are another option, stocks in this category are selected due to the consistent increase in their dividend payout over time.

In the end, the appeal of heading straight to purchasing your own stock directly from the company lies in the control you have over your choices. If you have the time, you can do some intensive research and really dig into each company’s performance history. Play your cards right and you can earn even higher returns than a fund can offer. 

Step 3: Review and Settle on Specific Stocks

Wondering what to look out for as you invest? Basic stuff really, check on the overall performance of the stocks, how well the parent company’s doing, whether dividends are being paid consistently, and if they’re increasing over time. 

Also, companies across different sectors like healthcare, finance, oil and gas, beauty, etc. can offer dividends. So if you choose stock from a company in a certain industry, you should keep abreast of developments, news, and trends in that industry. This can provide some insight into the strength of the industry and how current happenings may affect your chosen company, its earnings, and thus its ability to pay your dividends.

You can use tools like stock screeners which aid you in scouring the stock market. With a stock screener, you can sift through the market’s wide variety of offerings, narrowing down your search with metrics that matter to you such as dividend yield and stock price.

You can also conduct a sector-based search.

Other tools that could come in handy include portfolio trackers which keep an eye on your investment for you and analysis tools which review assets based on different criteria to deliver projections to users. 

Not sure where to start given the vast number of tools in existence?

Here’s a recommendation; Simply Wall St. This tool offers each feature listed above as well as additional utilities like letting you upload your portfolio and manage it from there. It’s available on desktop and mobile and does not require a subscription.

Step 4: Invest and Receive Your Dividends

Once you’ve settled on the stocks to buy, you’re just about done. However, besides actually owning the shares, the other requirement that must be in place for you to receive dividends from a company has to do with the timing. There are 3 dates to bear in mind as you make your investment. 

The first is the ex-dividend date.

To qualify as a recipient of a company’s profits you must already own shares of the stock by the time the ex-dividend date rolls around. It doesn’t matter if you make the purchase a day or a month before the ex-dividend date, just make sure it is not on that day. It’s like a cut-off date for anyone hoping to be a dividend-eligible shareholder to invest in a company’s stock. 

The reason is, that after the cutoff, a company’s stock usually gets cheaper because buyers from that point on won’t receive dividends. So the price of the units takes a hit because the value of the forthcoming profits is no longer being taken into consideration. In addition to this, it helps to keep things on the straight and narrow, all the parties involved know who is eligible to receive dividends.

The record date is another date you want to look out for, it is typically a day or two after the ex-dividend date. This is when the company compiles and updates its list of shareholders who qualify to receive the payout.

Finally, you’ve got the payment date. This is pretty straightforward, it’s when your passive earnings hit your account.

Things To Consider When Investing In Dividend Stocks

Now that you know how to add dividend stocks to your investment portfolio, it’s equally important that you be aware of the challenges you could encounter on your journey. Fortunately, we’re interested in showing you not just the potential pitfalls but also how you can evade them. Keep reading to find out.

1. Taxation

Dividend stocks can incur taxes. However, the taxation rate hinges on factors like how long you’ve held your position and what type of account is holding your stocks. Based on this, dividends are split into qualified and nonqualified dividends.

If you have owned your stock for at least 60 days before the ex-dividend date, then your dividends are qualified. This means the taxation rate will be the same as long-term capital gains which are 0%, 15%, or 20%, depending on your income.

Meanwhile, the IRS taxes nonqualified dividends at rates equal to the short-term capital gains rate meaning they’ll be taxed like regular earnings. These tax cuts range from 10% to 37%.

2. Dividend Cuts

It’s extremely important to bear in mind as an investor that companies can choose to cut down or even stop paying dividends entirely.

In 2020 for instance, Disney suspended its dividend payments to shareholders as it struggled due to the pandemic forcing the shutdown of some of its major sources of revenue. The theme parks were closed and productions went on hiatus.

Due to the possibility of occurrences like this, you need to be very careful when choosing a stock to invest in. Avoid companies with high debts and unrealistic earning projections. Learn to look past high-yields to see how many legs a company’s really standing on.

10 High-Yielding and Solid Dividend Stocks.

If you are just starting out, it might be a bit overwhelming to decide what stocks to invest in. So here are some recommendations:

1. Altria Group, Inc. (MO)
2. The Bank of Nova Scotia (BNS.TO)
3. Rio Tinto Group (RIO)
4. Ares Capital Corporation (ARCC)
5. Verizon Communications Inc. (VZ)
6. Realty Income Corporation (O)
7. Enbridge Inc. (ENB)
8. Main Street Capital Corporation (MAIN)
9. Volkswagen AG (VOW3.DE)
10. W. P. Carey Inc. (WPY.F)

Conclusion

You’ve come to the end of this guide to dividend stocks as a path to passive income. If you want to create a sustainable stream of income that will serve you and greatly benefit your portfolio in the long haul, you’re now equipped with the data you need to kick off your stress-free lounging as your money earns itself. 

Remember though, passive income takes minimal effort at the very beginning. You have to make good choices right off the bat to ensure your passive earning journey goes as smoothly as possible. So figure out your personal money goals and be sure to thoroughly research your choice of stocks to get the best results. 

Frequently Asked Questions

What are Dividend Aristocrats?

These are companies that have a solid track record of not only consistently paying dividends but also increasing them for 25 years consecutively. The general perception of these companies is that they make stable, reliable investments. They have a market capitalization with a lower limit of $3 billion and an average trading volume of $5 million.

What’s in it for dividend-paying companies?

Dividend payouts help companies attract investors and build a loyal pool of shareholders. Also, regular dividend payments help build a company’s image as a financially healthy and secure institution.

Are dividends a better investment than stocks?

This depends on your earnings goals. If you want a regular, low-effort stream of income, then dividends are the way to go. Stocks on the other hand feature higher earning potential and offer investors more flexibility.

Are dividends always safe?

As stated earlier, sometimes dividend cuts can occur where companies reduce or completely eliminate payouts because of a bad financial year or an economic downturn among other reasons. The two ways to mitigate this include targeting companies with a solid history of consistent dividend payments and diversifying your portfolio with the help of a good advisor or thorough research.

How exactly do dividends affect share prices?

News of a dividend payout might make a company’s stock more attractive to investors. The increased interest causes the price to shoot up allowing some investors to make a killing before the ex-dividend date. Once the cut-off passes interest might drop along with the price, however, this isn’t permanent. It is also more common among high-yield dividends.

How often do I have to check on my dividends?

This depends on the payment schedule but generally, you should check on your dividends regularly to stay on top of any changes in dividend payments, the company’s profitability or the general financial health in that sector.