What Are Dividends and How Do They Work?

One of the best ways to build long-term wealth is to invest your money in dividend-paying stocks rather than stashing it away in a savings account.

Companies pay dividends by redistributing their profits to shareholders. While not all companies pay dividends, some do, and they can help boost your portfolio.

What Are Dividends?

Some companies reinvest their profits into the company, while others share their profit with investors. When a portion of a company’s profits is shared with investors, it’s called a dividend.

If you're an investor, dividends are a way to earn extra income separate from a stock’s value.

Depending on your investment strategy, you can either keep dividend payments as cash or you can reinvest them to grow your portfolio.

Dividends are paid at regular intervals, typically each month or once a quarter, although some may pay just twice a year.

Not all companies pay dividends, but some companies, like real estate investment trusts (REITs), are required to by law.

One of the main draws of holding stocks in your portfolio from dividend-paying companies is that they can provide a predictable and recurring source of passive income. This kind of income can be particularly helpful when planning for your retirement.

That being said, dividends aren’t permanent. They can change depending on a company’s profitability or the state of the economy.

Some companies may increase dividend payments if the company is doing well. Others may pull back these payments if they’re worried about economic uncertainty.

The decision about when to change the payment and by how much is made by the company's board of directors.

How to invest in dividend-paying stock

You can access dividend-paying stock through any brokerage account, including online investing platforms like Webull or M1.

Both are accessible for beginners, have user-friendly interfaces, and offer educational resources, so you can keep learning as you invest more.

RELATED: How To Start Investing

Dividend Terms to Know

Before investing in dividend stocks, there are a few key terms you should know: 

• Dividend per share: The amount that a company pays out per share of stock owned. For example, if a company pays $0.50 per share and you own 1,000 shares, you’ll earn $500 per quarter in dividend payments, or $2,000 per year.

• Dividend yield: The annual dividend per share price divided by the share price. It shows the return on investment you can expect to make from the stock.

• Ex-dividend date: The cut-off date to have dividends paid for the current payment period. Stocks purchased after this date will receive a payment in the following payment period.

• Record date: The date you, as a shareholder, must be in the company’s records to be eligible to receive a dividend.

• Declaration date (or announcement date): The date a company’s board of directors announces the next dividend payment.

Types of Dividends

Depending on your goals, there are a few different types of dividend-paying stocks you can choose from:

• Cash dividends: These are cash payments made straight to an investor, usually deposited into your brokerage account. If you choose to, you can reinvest your cash dividends back into the company’s stock to grow your portfolio.

• Stock dividends: Rather than paying cash, some companies increase the number of shares an investor owns as a dividend payment.

• Special dividends: Instead of regular payments, special dividends are one-off distributions, usually tied to an event like the sale of an asset or a liquidation.

• Preferred dividends: Stocks can be offered in different classes, with preferred stock having higher priority over regular common stock. Dividends earned on preferred stocks are usually paid out ahead of common stockholders.

• Property dividends: Occasionally, companies pay investors with property rather than cash or equity. It can include things like physical property or products.

How Are Dividends Paid?

Dividends are usually paid out every quarter, but some dividends are paid every month or twice a year. REITs are one of the most popular types of stocks that pay monthly.

The board of directors will announce the dividend date and when investors should expect to receive their payment.

Dividends are paid from a company's profit and are usually deposited directly into a shareholder's brokerage account as cash. Or, if you participate in a reinvestment program, it will be reinvested in the company’s stock instead.

While dividends can be a great way to generate recurring income, they aren’t guaranteed. If something happens, the board of directors can decide to halt dividend payments. For example, Unilever cut its dividend following the 2008 global financial crisis.

How Are Dividends Taxed?

Dividend payments are taxed like income. The rate at which they are taxed depends on whether the dividend is considered “qualified.” 

It is considered non-qualified if you purchased a stock 60 days or less before the stock’s ex-dividend date. If you’ve had a stock for more than 60 days following the ex-dividend date, then it’s considered qualified.

Non-qualified dividends are taxed as regular income, while qualified ones are taxed as capital gains.

There are some exceptions to how dividends are taxed. If a dividend-paying stock is purchased in a tax-advantaged retirement account, like a Roth IRA, any dividends earned aren’t taxed (unless you make an early withdrawal).

RELATED: Understanding Passive Income vs. Earned Income

FAQs

TL;DR: Earn Passive Income from Dividends

Dividends are regular cash payments that some companies share with their investors. You can either pocket the cash or reinvest it to buy more shares and compound your growth.

You can find dividend-paying stocks through any brokerage account, including investing apps like Webull or M1.

Just note that not all companies pay dividends, and they're not guaranteed — boards can cut or eliminate them if business slows down.