The Advantages of Paying Dividends

One way for companies to reward their investors is to pay dividends. Dividends are payments made by a company to its shareholders, with the total amount of the payment to each shareholder determined by the number of shares the investor owns. Dividends can be a regular occurrence or only on a special occasion.

When companies pay dividends on a consistent basis, they demonstrate stability to investors who are looking for solid returns over the long term. Investors who select dividend-paying stocks also gain a measure of predictability in their returns. Even if the stock has a rough year, the investor will still be able to receive a return in the form of a dividend.

When a company pays dividends, investors reap some profits without having to sell their shares. With growth stocks, the only way an investor can realize a gain is to sell her shares. A dividend-paying company lets an investor continue to own part of the company and still benefit financially.

In 2003, the federal government slashed the tax rates on qualified dividends to 15 percent for investors in tax brackets of 25 percent or higher. Through 2007, lower-income investors paid 5 percent tax on dividends, then that rate fell to zero through 2010. Before 2003, dividends were taxed at an investor's marginal rate, which could be as high as 38.5 percent. The tax cut allowed higher-income investors to keep more of the money paid out to them. However, these tax advantages are scheduled to sunset at the end of 2010.

If a mature company has fewer expenses related to expansion, and research and development, and cannot reinvest enough of its revenue in the company, it may find itself sitting on excess cash. Investors in dividend-paying companies prefer the money be paid out so they can invest the money elsewhere and seek higher returns.