Stocks that pay dividends provide steady income for you. However, your stock value may not grow because the company keeps paying you profits as dividends instead of reinvesting in the company. Growth stocks, which don't pay dividends, tend to grow faster than dividend stocks because these companies reinvest profits in the company. This increases the value of your stock. Both types of stocks can help you meet your investment goals.
Stocks that pay dividends give you cash monthly or quarterly. If you find a stable company that has consistently paid a dividend, you can create income you can rely on, barring any unforeseen catastrophe in the stock market. Retirees find this style of investing attractive because they're interested in current income much more than future growth. If your main goal is income, you may want look at dividend-paying stocks.
Companies That Can't Grow
Companies can fail because they pay out so much cash in dividends. They may forgo buying new equipment or opening a branch so they can maintain their dividend payments. Occasionally, such a company has to cut or eliminate its dividend so it can pay for expansion. When investors see a company stop paying its dividend, they may sell their stock because they think worse news is on the way. When large numbers of investors sell at once, the price of a stock tends to go down. You get a double hit: missing dividends and a decrease in the value of your investment.
Increase in Price
Companies that don't pay dividends can put the cash to work by purchasing equipment and other assets that can increase future profits. When a company grows steadily, its stock tends to grow, too. Your investment in such a stock can increase in value, and you can take your profits when you sell it. Because growth stocks are more likely to go up in price than dividend stocks, they can increase the value of your portfolio better. If you want to see your investment value go up, consider growth stocks.
No Profit Guarantees
Nondividend stocks don't necessarily grow. The company can be mismanaged or get into debt trouble, and the stock may not rise in value. If you were counting on the stock to increase your portfolio, you may be disappointed. In fact, such stocks can go down in price if the company cannot recover from its problems.
A Blended Style
You can look for dividend-paying stocks that have a history of boosting their dividends. A company that has consistently increased how much it pays in dividends offers income and growth at the same time. For example, Coca Cola's stock price grew only 7.5 percent in the 10-year period beginning in September of 2000. However, if you add in the dividends it paid during that period, your actual return on your investment would have been 50 percent.
Dividends and Taxes
Dividends make for some interesting choices between taxable and nontaxable accounts. A Roth IRA, for example, lets you hold a stock as it goes up in value, reinvest all the dividends in the stock and not pay any taxes on your gain. With a Roth, your withdrawals are not taxable when you retire. In a traditional IRA, you don't pay taxes on dividends as you earn them, but you will pay tax when you start to withdraw money at retirement.
Capital gains are the profits you get when you sell a stock for more than you paid for it. Capital gains typically are taxed at a lower rate than regular income. If you have capital gains in a traditional IRA, you don't pay any capital gains tax when you earn the gains, but you pay for withdrawals when you retire. Here's the catch: all of your retirement withdrawals are taxed as regular income, even if you have capital gains earnings in the account. If you are in a higher tax bracket, you won't get the advantage of the lower capital gains tax. With a Roth IRA, you don't pay tax on withdrawals at retirement, so you have no worries about capital gains taxes.
- U.S. News & World Report: Time to Ditch Dividend Stocks?
- Seeking Alpha: Backtesting Dividend Growth Vs. Dividend Yield
- Scottrade Knowledge Center: Dividends vs. Growth ... or Both?
- Seeking Alpha: High Yield Versus High Growth: The Dividend Growth Conundrum
- Business Insider: Great News, Rich Americans, Looks Like Obama's Caving On Dividend Taxes!
- Seeking Alpha: Roth IRA Plus Dividend Growth Stocks Equals Success
- IRS.gov: Topic 451 -- Individual Retirement Arrangements
- Charles Schwab: Withdrawal Rules
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.