Dividend stocks are a great instrument for investing, offering shareholders an opportunity to generate income simply for holding a certain amount of shares. This passive profit is enticing to many, making dividend stocks a popular investment that’s usually lower risk than alternatives.
What are dividend stocks?
While not all stocks pay dividends, companies can decide to redistribute a portion of their profits to shareholders through dividend stocks. This is a great financing instrument for companies which can be used to attract the interest of potential investors and increase the company’s funds through selling stocks. The more shares a given shareholder possesses, the more dividends they are paid.
There are pros and cons to every type of trading, and you should always choose the one that best fits your investment strategy. Ensure you’ve researched the market to identify high dividend stocks before making a decision. That being said, let’s go over the advantages and disadvantages for traders:
The pros
The additional income that dividends provide over time is a huge advantage, bringing profits to investors regardless of short-term market fluctuations. The amount of dividends being paid out depends on the amount of shares each shareholder holds, but not on the price of the shares at a given moment. Dividend stocks don’t require you to actively make predictions about the market on a regular basis – they can still bring in profit.
Dividends can grow with time, providing shareholders with increasing profits as the company expands. They also do not fluctuate with the market, giving you a sense of security even in a bearish market. Companies with good dividend paying history and steady cash flow make for good dividend stocks, which are a low-volatility asset that can improve your portfolio.
Dividends also feature a preferential tax treatment in many countries, including the United Kingdom. In the UK, up to £2,000 in dividend income can remain untaxed every year. The dividend tax after that depends on your Income Tax band, ranging between 8.75% for basic rate and 39.35%. Find out how uk dividends stocks are taxed in the UK at gov.uk.
The cons
Even though there are advantages, there are also some potential risks and disadvantages to consider. Review both pros and cons carefully beforehand and make sure your course of action fits in with your trading strategy.
While dividend stocks are less volatile and overall less risky than traditional trading, they usually don’t offer as high of a potential for profits. Profits from dividends are stable, but only make a difference in the long term. Even if a company has a high yield on their dividends, it probably still won’t reach the profit potential of growth investments.
Also, dividend cuts can happen for a variety of reasons. This usually happens when a business is struggling, companies can decide to cut or cancel dividends at any time. This is especially relevant in the case of common stocks, which are not legally required to provide dividends.
Finally, it might be hard to create a diverse portfolio from just dividend stocks, as many of them are found only in certain industries. As such, if you were to invest solely in dividend stocks, you might find your portfolio lacking. While dividends can be a great opportunity, they probably shouldn’t be your only option.
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