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Investing 102

Deeper dives on diversification, wealth-building, and making the most of every investment

Dividend Discussion: What You Need To Know

March 15, 2022

A key concept investors should know before they begin building a portfolio is how dividends work. Dividends are rewards paid out by companies to shareholders at regular intervals, and these payments can vary in type and amount, depending on the type of investment you hold. Stock market dividends, for example, are typically paid out in cash or additional shares. REIT investments, like those offered by DiversyFund, have the potential to pay out at higher rates and can carry with them some unique tax implications. Here is a closer look at how dividends work in these two different financial sectors to help you fine-tune your investment strategy.

Stock Market Dividends

Stock market dividends may be paid out on a monthly, quarterly, or yearly basis. Some companies choose to pay out in cash, while others offer additional shares of stock or warrants to purchase stock shares at a specified price. It’s important to note that companies are not required to pay out dividends at all, and the board of directors for any organization can change the dividend strategy to suit the company’s needs. Approximately 84% of companies on the S&P 500 offer some form of dividend, though the average yields can vary greatly from one organization to another.

The average dividend paid out in the United States in 2021 was roughly 1.29%, providing a better return than you might see with some high-yield savings accounts. It’s important to note that not all stockholders investing in the same company will receive the same dividend payout. Common stocks may pay less than preferred stocks, so investors will need to keep this in mind when purchasing shares.

REIT Dividends

REIT dividends differ from stock market dividends in a number of ways. All REIT investments are required to pay out a minimum of 90% of their taxable income, and the result is regular dividends paid to investors. These dividends can be paid out as a reinvestment in the company or product, and they can also be distributed as cash. As part of our value-add strategy, DiversyFund automatically reinvests monthly dividends. Reinvestment provides funds REITs can use for value-add renovations on existing properties or purchases of new properties. This process can create a cycle of growth and even larger dividends as time goes on.

Because of the unique way REITs operate, they come with different tax implications. REITs are considered “pass-through businesses,” and this designation means taxpayers can deduct up to 20% of their income from dividends. A pass-through business is one that passes out its profits to investors. Not all of the distributions you receive will qualify as pass-through income, as they are allocated in several ways. It’s always best to consult with your tax expert or attorney to ensure a complete understanding of tax laws and their direct impact on your investment strategy.

Dividend Yields

When examining dividends paid out through any type of investment, it’s important to understand what a dividend yield is. The yield is the amount a company pays out per share divided by the current price of the share. This is true for both stock market dividends and REIT dividends.  When this equation is calculated, it does not include any one-time payments to shareholders, which are considered one-offs and not predictive of a share’s expected yield over time. Investors, such as retirees, looking for a potentially steady stream of income may take dividends into account as a way to achieve their financial goals.

Yields provide an excellent way to compare individual stocks or REIT investments side by side to help determine the strongest performers. You can also use the yield spread to compare the expected rate of return between different types of  investments, such as REITs and stocks, to better inform your strategy as you expand your portfolio. The spread essentially shows a side-by-side comparison of two investments over the same period of time, so you can see changes in dividend yields.

Stocks Versus REITs

When it comes to paying out dividends, there are key differences to keep in mind. Yields for REITs tend to be higher than those for stocks, with the FTSE Nareit All REITs Index showing a 3% dividend yield, which outpaces the S&P 500’s 1.2% dividend yield. REITs are able to show higher yields due to a number of factors, including their position as “pass-through” companies. The requirement of paying out a minimum of 90% of their taxable income can mean higher dividends compared to traditional stocks. It’s also worth noting that some stocks may show high yields as a result of declining stock prices and not consistent growth and performance, and companies can choose to stop paying dividends on stocks at any time. 

Understanding dividends, dividend yields, and tax implications for different investments can make it easier to pinpoint the strategy that works best for your current situation and future financial goals. While the stock market offers a diverse selection of opportunities, REIT investments provide higher average yields and unique tax implications. Expanding your portfolio might consist of a mixture of both options, or you may prefer to stick with a strategy that provides regular dividend payouts and reinvestment options to help grow your wealth.  

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