Banks pay interest as rent for the use of your money. This concept is substantially different from a sharing of business profits, like dividends. Because interest is an expense, banks prefer to pay the lowest rate possible to attract your money. Banks benefit from the spread between the interest they pay you and the interest and fees earned from loaning your money to others. Like dividend payments, bank interest payments are subject to change.
Dividends, on the other hand, are a distribution of profits by companies to their shareholders. Profits indicate that a company is financially successful. Linking your income stream to companies that enjoy business success may be preferable to receiving interest declared by the bank. Owning a diversified pool of companies through a mutual fund may help spread the risk that any particular company may experience adverse business results. While you have investment risk when receiving dividends, you also have the possibility of an income yield that may be higher than interest paid by the bank.
Dividend-paying stocks may offer a better hedge against inflation than a bank account. When the cost of goods and services rise in an inflationary period, companies that produce those goods and services raise prices to offset the higher costs of doing business. In raising prices, companies maintain their profit margins and distribution of those profits to shareholders. Banks, on the other hand, pay interest rates that do not take inflation into account. If you receive 1% interest on your certificate of deposit or savings account, but the annual inflation rate is 4%, the value of your deposit has eroded by 3% in purchasing power over the course of a year.
Both short-term dividends (held less than one year) and interest are taxed at the ordinary income rate in the year paid. There is no tax advantage to either one as a source of income. Long-term dividends (held more than one year) are taxed at either 0% or 15%, depending on your tax bracket. There are some tax provisions that affect the shares that produce dividends. Stock values may increase or decrease, unlike a bank account deposit value which remains the same. An increase in stock portfolio value, when sold for a profit, will be taxed at a capital gains rate--which is currently lower than the ordinary income tax rate for most people. A decrease in portfolio value, when sold for a loss, may be deducted from taxable income as a capital loss.
If you need to know that your investment amount will be insured against loss, then the bank account is for you. Everyone has some assets that fall into this category. However, for those who are willing to have a portion of their assets at work in the business marketplace, dividend income is an attractive vehicle for participating in the distribution of profits.
Howard Feigenbaum is Registered Principal and Owner of Sharemaster, a Broker-Dealer firm that specializes in monthly dividend income funds.
"Do you know the only thing that gives me pleasure? It's to see my dividends coming in." - John D. Rockefeller
This article is a general discussion of the subject and is not intended as a solicitation or specific investment advice.
Copyright 2011 Sharemaster
http://www.monthlydividendcheck.com/
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