A dividend is a portion of a company’s profit that’s paid to shareholders. That means dividend-paying stocks may provide a source of income. But they can also carry some degree of risk.
So, what do investors need to consider when it comes to dividend-paying stocks? In this Q&A, Austin Pickle, senior wealth investment solutions analyst with Wells Fargo Investment Institute, provides important information for investors to keep in mind.
“One of the big benefits is that these stocks may provide a more reliable income stream compared to some other investment options,” Pickle says.
Companies tend to issue dividends on a routine basis, such as quarterly or semi-annually, which may create a dependable income stream. Another benefit? The stocks can yield some favorable tax treatment.
“It’s going to depend on your tax situation,” Pickle says, “but in general, you may have a relatively lower tax rate for dividends compared to income gained by selling investments.” As long as the dividend-paying stock meets IRS requirements for a qualified dividend, the dividend is taxed at the lower long-term capital gains tax rate instead of being taxed as regular capital gains income. “So, an investor could receive income from a dividend-paying stock without selling the stock and have a lower tax bill compared to that of a non-dividend-paying stock, which must be sold to receive income,” he says.
Many types of investors have the potential to benefit from dividend-paying stocks. “But these stocks may be more valuable for investors who are a bit older — maybe those in retirement or close to retirement who really value a more reliable income stream,” Pickle says. “I think they’re typically beneficial from a diversification perspective, especially when interest rates are low. Dividend-paying stocks tend to have an inverse relationship with interest rates: When interest rates go down, you may see some of these dividend-paying stocks perform better.”
“Firms can reduce or cancel their dividends — especially during times of economic uncertainty and times of crisis,” says Pickle. “And there’s still the risk that dividends could be cut periodically, even without the trigger of a crisis event. And if tax rates change, it could mean you’d pay more, as well.”
Explore your options with professional advisers
Pickle stresses that investors should discuss the pros and cons of dividend-paying stocks with a financial adviser to help make sure they fill a need within an individual investment portfolio and make sense for a specific financial situation.
“You should also talk to your CPA or tax professional to make sure that you understand what the tax consequences are for your particular situation,” he advises.
Equity securities are subject to market risk, which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Investments in equity securities are generally more volatile that other types of securities. There is no guarantee that dividend-paying stocks will return more than the overall stock market. Dividends are not guaranteed and are subject to change or elimination.
Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
Our firm does not provide legal or tax advice.
This article was written by/for Wells Fargo Advisors and provided courtesy of Jamie Seim, CFP, Senior Vice President – Investment Officer in Ponte Vedra Beach at 904-273-7917.
Investment and Insurance Products are:
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC, Member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company. CAR-0723-01137
©2023 Wells Fargo Clearing Services, LLC.
