I think dividend investing is an amazing wealth and income generating vehicle. Collecting stable dividend payers to my portfolio is a great feeling. I know I’m not only securing income for today but potentially getting into an investment that will pay me even more at a later date. All for the same initial price. Not to mention I’m taxed less on that income.
Why Dividend Investing?
If you’ve never heard the wheat and chessboard story, it’s a perfect explanation of compounding. The stories seem to differ on the background but the point is the same.
When we buy a dividend paying stock that contributes consistent dividends, we pay one price for that asset. However, those dividends that we get back and reinvest earn dividends. The more you reinvest, the more those dividends earn dividends of their own. Before you know it, your money is working for you!
Tax Advantages for Qualified Dividends
The Tax Cut Job Act (TCJA) changed the way dividends are taxed. Check out this Marketwatch.com article for a more detailed breakdown. To keep this explanation brief, qualified dividends are taxed between 0%, 15%, and 20% depending on your tax bracket. That means, your dividends earn you significantly less tax burden than earned income. Now, not all dividends are qualified, so I advise you to understand the difference. It’s good to know that income generated by qualified dividends have a reduced tax, especially in retirement. Many people have a strategy to drop a tax bracket in retirement for this exact reason.
Unqualified dividends are taxed at the individual’s earned income rate. Quite often, people hold these in tax-advantaged accounts, like the Roth or a traditional IRAs. That way, they don’t have the issue with taxes.
If I make an investment in a dividend paying stock, I have a clear idea of what it’s paying today. Over time, the company’s growth may slow. Or, maybe they have consistent returns and enough capital to operate without needing to reinvest in the business. The company should always want to provide value to shareholders. Dividend increases are a way to do that. Stop and think about what that means. This hypothetical company literally gives you a yearly raise, and you didn’t have to do any research, trade, or anything special. Researching dividend paying growers is an excellent way to grow income over the years without putting in much effort. You just need time.
Dividend investing is a powerful tool for those seeking financial independence. If the goal is to reduce dependence on a regular job, this is a great option. Qualified dividends save you on the tax bill over earned income. That’s part of the strategy to reduce your tax bill in retirement. Most dividend investors focus on stocks that are growing their dividend instead of the share price appreciation. Accumulation of a diversified basket of blue-chip dividend payers is a boring, yet effective way to start down the path of passive income.