What Kinds of Dividends are Best for You?
What if the stock you purchased could pay back your investment before you sell it? With dividend-paying stocks, you get exactly that.
But first, you have to choose the right kind of dividends.
Here’s a look at the most common types of dividends, how they work, and how to know if each one is the right fit for your financial goals.
The most common type of dividend, a cash dividend, is a type of dividend paid directly in cold hard cash. Most people prefer this type of dividend over others since it allows them to use the capital right away.
With cash dividends, you’ll get periodic payments from the company’s accumulated profits. These typically arrive quarterly, though some stocks pay them monthly, semiannually, or annually. Like all other dividends, these are paid on a per-share basis.
Here’s the catch: since you’re getting a cash payment, the IRS treats it like income and you’ll have to pay taxes on it.
If you’d rather not pay taxes on your dividends, another popular option is a stock dividend. It works exactly the same way as a cash dividend, but instead of paying cash, it pays in stock shares.
This has a few key advantages for the company. For one thing, stock dividends can reward investors without cutting into the company’s cash balance. However, stock dividends also dilute earnings per share, since they are distributed fractionally. For example, you might get 5% of a stock as your stock dividend. Everything works the same as a full stock. The only difference is that you earn money on the stock based on the percentage of a whole stock you own.
Scrip dividends are like cousins of stock dividends. They’re paid in the form of a certificate to shareholders, who have the choice of receiving cash at a future date or receiving additional stocks now without paying for their added shares.
Companies typically opt for scrip dividends if they don’t have the cash for cash dividends or they want to invest their available cash rather than distributing it.
From the shareholder side, this type of dividend is beneficial because it provides compensation even if the company lacks funds to distribute dividends. And once you have your cash or stocks, you can either collect it as capital gains or sell.
A property dividend is another alternative to cash or stock dividends, though the option isn’t as popular.
As the name implies, the dividend is paid as property—either shares in a subsidiary or company-owned physical assets like real estate or equipment. Bookkeepers record the dividend at the asset’s market price. Once the dividend is distributed, shareholders can hold onto it as long as they’d like.
For companies, this is a way to avoid diluting their share value or to reward investors even if they don’t have the capital to make payments. From the investor side, this is another useful type of dividend to reduce or defer taxes.
Liquidating dividends are unique in that companies don’t offer them very often. In fact, a company only ever offers a liquidating dividend when it’s going through partial or full liquidation in order to return business assets to shareholders.
In other words? You’ll only see liquidating dividends when a business is closing its activities and exiting the market. This can be a voluntary or involuntary decision, depending on the situation.
As the name implies, special dividends are a unique case. Unlike most other dividends, which are paid out on some sort of regular basis, special dividends are only paid out once.
A special dividend is usually paid in a higher amount than a regular dividend. It doesn’t affect the size of the regular dividend because special dividends typically happen when the company has unusually strong earnings for that period and decides to share some of the profits with shareholders.
Basically, think of special dividends like a surprise holiday bonus. You can’t plan for them, nor can you count on them to arrive, but they’re a pleasant surprise when they do arrive.
Last but not least are preferred dividends, a type of dividend allocated to a company’s preferred shares. Basically, these are the shareholders who are always first in line when payouts are on the table. Or, put another way, if a company can’t afford to pay dividends to everyone, it pays preferred shareholders first.
The only way you can access preferred dividends is by becoming a preferred shareholder, and there are certain benefits to doing so (other than always being first in line for payouts, of course). Preferred shareholders get higher yields than common shareholders, which is the main reason most investors become preferred shareholders.
The one downside is that preferred shareholders often purchase shares in large groups. Because of this, each individual preferred shareholder forfeits their right to vote in certain company matters, so they have no say in business decisions that may affect the direction of the company.
Ready to Move Beyond Dividend Investing Basics?
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