“Compound interestis the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it.” – Albert Einstein
More than 950 companies have cut their dividends in 2015 and 2016 according to Stockwatch.com. And some cuts have been huge, from Nextstar Broadcasting who completely eliminated its dividend to
Peabody Energy with a 97.1% reduction and Freeport-McMoran with an 84% dividend cut.
Stockscan provide regular dividends and growth, but deep reductions can be disastrous to your income stream. Consistent, long term dividends and increasing dividends are usually a sign of corporate stability and growth. Not declaring an expected dividend can destroy investor confidence and have severe price consequences, so it’s not done willy-nilly. Remember, a stock dividend is declared at the discretion of the board and is not guaranteed.
Bonds present a different picture because companies are legally required to make regularly scheduled payments or else the bondholders are entitled to underlying collateral. Bond payments are also referred to as coupons, a hold-over from the days before massive computerization, when investors literally had a coupon book and had to ‘clip the coupon’ and submit it for payment. While bond payments can’t be lowered, the value of the bond itself is subject to regular market turmoil.
If you want consistent stable income, corporate bonds are perhaps the better choice and do not require much monitoring on your part. Like stocks, bonds can be purchased individually or within mutual funds. Unlike a stock, a bond has a termination date whereupon you get your principle investment returned. With a little research and savvy, income investors can collect 8%-12% or more from distressed corporate bonds, which are also guaranteed.
Dividends are distributions that corporations pay to their shareholders and are classified as ordinary or qualified. While both are taxed, ordinary dividendscome from corporate earnings and are taxed the same as ordinary income. Qualified dividendshave a more favorable tax treatment because they are considered long term capital gains. For most taxpayers this is 15%. However, if you fall into the 10% or 15% tax bracket, you do not pay any tax on your qualified dividend gains. By comparison, tax on ordinary dividends can be as high as 39.6% while qualified dividends are capped at 20%.
Reinvesting your dividends creates compounding which allows your investment to generate earnings on reinvested earnings. Some stocks allow for automatic reinvestment of dividends which will propel your portfolio forward faster. In tax deferred retirement accounts, the power of compounding interest is enhanced because the entire dividend is sheltered and can be reinvested for years and years. “A tax deferred annuity can be an excellent supplement to your 401(k) or IRA retirement plan because it does not have contribution limits or mandatory withdrawals at age 70 ½,” says Rick Althoff, owner of Financial Planning Associates in Sioux Falls.