A dividend is akin to a profit distribution paid to you by the company you own stock in. A stock’s “yield” equates to the rate of return its dividend pays when calculated against its current trading price. For example, assume XYZ company is trading at $20 per share, and it pays an annual dividend of $1 per share. This means that for every share you buy of XYZ you will receive $1 per year in the form of a dividend payment. Dividends are typically paid once per quarter. Investors can think of a stock with a dividend in terms of a CD — in the above example if you bought shares in XYZ you would generate 5% return via dividends. However, unlike CD’s, the value of stocks can go down.
There are several advantages of dividends. In terms of taxation, dividends are currently taxed at a rate of 15%. There is talk that this will soon raise to 20%, but even so it is far less than the equivalent earned income tax rate. Additionally, dividends can provide a good income stream and also allow for eventual upside appreciation from owning the underlying stock. Those looking to invest for the long term are most often far better off including high paying dividend stocks in their portfolio as opposed to stocks which do not pay a dividend. Any stock with a dividend yield of over 4% is considered high yield. When you do the math, receiving 4% dividends over 20 years of holding a stock yields quite a bit of income — taxed at a low rate. The next time you go to select a stock for your long term holdings, the first thing you should check is its dividend yield.