Drop the Savings Account - Dividends Are the Way to Go
By Joshua Saunders
When the economy is struggling, the Fed lowers interest rates to encourage investment. There are two major downsides to this for consumers.
1. Inflation increases. As we have seen, the price of many goods has increased. Economics 101- As inflation increases, your purchasing power decreases, meaning you could now buy less with the same amount of money.
2. Lower interest rates encourage investment. If you are looking to borrow money, this is a great time to do so. The flip side is that if you're lending, you are getting a lower interest rate. And when you put money in your savings account you are doing just that, lending money to the bank.
Savings accounts almost always pay very low interest rates. For the average person, expect tenths of a percentage point from major banks. You could do a lot better from specialty banks such as ING or Emigrant Direct. Even these banks have significantly lowered there rates, ING is only offering 1.75% now for accounts up to $50,000. If you have more money, you can do a little better with these or money market accounts. But the fact remains, with low interest rates and high inflation, you aren't in a good position.
In comes the stock market. For newbies out there, dividends are cashflows paid to equity investors (shareholders) in the company. Established, profitable companies often pay dividends to investors in return for their equity investments. New, high-growth or unprofitable companies tend not to pay dividends.
While I always suggest investing in a diversified portfolio of investments for the long-term, investing in high paying dividend stocks and funds can also be a great way to save, for the short or medium term. One thing to note, dividends are taxed, either as income or as a qualified dividend (based on holding period), so when considering the cashflow include the discount for the taxes you will pay on it. There are tons of great stocks and funds that offer great dividends. Some basic info you should know:
- Preferred Stocks: have first rights over assets of the company after debtors and are more like bonds - some pay decent dividends.
- Stocks: As I said earlier, some pay nothing at all, some pay great dividends. Just because a stock pays high dividends, doesn't mean its a great company, the stock price could still decline. (Watch out Pfizer!!!)
- REITs: Real Estate Investment Trusts are vehicles used to invest in, you guessed it, real estate. By law, REIT's must pay out at least 90% of their profits in dividends, making them especially appealing. However, they have tanked in recent years with the real estate bubble. Watch for these making a comeback now though.
- ETF's: Exchange Traded Funds are a collection of stocks, similar to a mutual fund. It is a great way to diversify holdings if you don't have a lot of money to invest. There are also some good ETF's that pay decent dividends.
- Dividends and Dividend Yield: Dividends are specified in dollars per share. So a divident of $1 will pay $1 for every share you own. The lower the stock price the more shares you could buy obviously, so an important measure is the dividend yield. This specifies the dividend paid divided by the stock price. When comparing stocks, the dividend yield will directly show you which paid a higher dividend compared to its stock price.
- Dividends are paid to shareholders of record on a certain date. This date is called the Ex-Dividend date. It is not the same as the date the dividends will be paid. And... companies are NOT required to pay dividends. They can change their dividend at any time or simply not pay it. Although this will have repercussions on their stock price.
Hopefully, now you can see why dividends can be a good investment strategy for saving. If you are looking to save as part of a long-term strategy, I would strongly advise you reinvest dividends. This means you aren't paid the dividends in cash, but instead get them in stock. This additional stock compounds and leads to higher dividends and more stock ownership over time. Right now is a good time to look at dividends that can make you more than a savings account. There are endless options of investments with yields from 3% to 15% that may be good buys.
Joshua Saunders is a new business development professional. You can see his bio by visiting http://www.joshuasaunders.com