Dividend Investing in Plain English

One of the best ways to build wealth is to invest in stocks that pay dividends. 

Dividend stocks not only give you the opportunity to make money through capital appreciation, they also provide a steady source of income as long as you own the stock.

But what exactly is dividend investing and how do you get started?  This article aims to answer those questions in plain English that anyone can understand even if you don’t know the first thing about investing.

First, let’s answer the most common question people have:

What is a Dividend?

When a company earns profits they can use those funds in different ways.  They can use profits to pay down debt, put them toward future projects to grow the company even more, or return them to shareholders in the form of a dividend.

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In other words, a dividend is an individual investor’s share of the company’s profits.

Of course not all companies pay dividends.  Generally speaking, companies that are young and still rapidly growing don’t pay dividends to shareholders because they need to keep funneling all of their profits back into the company to continue growing.  This is why most of the exciting new startups and tech stocks that you hear about on the news don’t offer dividend payments.

Older companies that are more mature and stable are more likely to pay shareholder dividends.  They still want to grow their business, but they have proven over time they can sustain a level of success and share their profits with investors.

Apple is one example of a company that went many years without paying dividends because they were always busy coming up with the next craze to take the world by storm.  But these days they can’t make the iPad and iPhone fast enough and they literally have more money than they know what to do with, which is why they are paying some of their cash reserves back to shareholders through dividends and stock buybacks.

Advantages of Dividend Investing

Stocks that pay dividends have several advantages over non-dividend paying stocks…

Passive Income.  Once you purchase the shares, dividend income is almost entirely passive.  Just sit back and watch the dividends come in each quarter.  You can take them as cash to supplement your income or reinvest them to purchase more shares which will in turn generate their own dividends.

Stable Companies.  As we noted above, most companies that pay dividends have already proven they can stand the test of time.  Of course, there is no guarantee that a dividend company won’t run into trouble down the road.  A good way to guard yourself from troubled companies is to obtain a financial report on the company you are looking to invest in.

Profit without Selling Shares.  With non-dividend stocks, any increase in value is only paper profits unless you actually sell the shares.  But with dividend stocks you can take a portion of those profits as dividends and still keep your ownership stake intact.

My Dividend Investing Strategy

I’m a big fan of stocks that pay dividends.  I enjoy taking advantage of the power of compounding by reinvesting dividends to purchase more shares.

I have an account with Sharebuilder that I call my Dividend Machine.  I contribute to it every month and buy a handful of large company stocks that pay dividends.  I mostly focus on the Dividend Aristocrats, which is a group of companies that have increased their dividend payout each year for at least 25 years, but there are many other great dividend paying stocks that are not part of that group.  You can also purchase dividend ETFs which focus on purchasing dividend paying stocks.

Although the reinvested dividends start off small, they grow quickly if you continue making contributions.  Imagine rolling a small snow ball down a hill and watching it grow into a giant avalanche as it gathers more and more snow on its way down the hill.  Given enough time a small dividend investing account could turn into an unstoppable financial juggernaut.

What do you think about dividend investing?  Do prefer stocks that pay dividends or those that don’t?

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Mike is a freelance writer and blogger who specializes in finance and parenting topics. He is a dedicated husband and father of three who is obsessed with creating multiple streams of income and building wealth so he can achieve true financial freedom for his family. Like what you're reading? Subscribe to our free RSS feed and follow us on Twitter.

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Comments

  1. says

    Great overview! I do worry about the idea that dividend-based investing creates passive income. While it’s true that you’re not doing any hard labor to earn those dividends, you do have to keep an eye on your investments… and that requires an active approach to investing. Better than trading your time and efforts for an hourly wage, certainly, but not free from participation and management.

    • Mike Collins says

      Hi Flexo! Thanks for stopping by. You make a valid point…dividend income isn’t 100% passive. While you receive the dividend payments without doing anything, you do need to monitor your investments and make adjustments as necessary.

  2. says

    Great article Mike. I am of course a big fan of dividend investing as well. I’ll add that there are still plenty of dividend-paying stocks that aren’t safe. When you consider that almost 800 US stocks have a dividend yield over 3% you can start to imagine that not all of these stocks are good investments. The dividend aristocrat list that you highlighted is a good place to start for safe dividend companies.

  3. says

    In my opinion, dividend investing is a great way in order to gain profit or make your business more successful. We only need to be careful and patient and also search the stable companies that pay dividend regularly.

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