Another New Year's Day is upon us, and with it the prospect of a better and more prosperous year. If you're feeling like most, it won't be hard to top 2020.
While you're carefully considering your resolutions for the new year, more dividend income should be near the top of your list. Here are five reasons you need more dividend income in 2021.
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1. Dividend income has lower taxes
One of the more consequential changes in tax policy occurred not in 2017, but in 2003 when President George W. Bush signed the Jobs and Growth Tax Relief Reconciliation Act into law. The bill created a separate category for qualified dividend income and lowered the maximum rate to 15% versus previous treatment as ordinary income. This maximum rate was later increased to 20% for those earning in excess of $440,000 for single filers (higher for married taxpayers).
What does this mean for you? Simply put, you'll keep more dividend income in your pocket! Assuming the median household income of $68,700 and single-filer status, this is a breakdown of $1,000 of dividend income versus wage income at the 22% marginal rate.
|
|
Gross |
Taxes |
Net |
|---|---|---|---|
|
Dividends |
$1,000 |
$150.00 |
$850.00 |
|
Earned income* |
$1,000 |
$296.50 |
$703.50 |
*Includes FICA taxes of 7.65%
While it's important to note tax situations are highly individualized and subject to many factors, the 15% tax is among one of the lower rates charged by Uncle Sam.
2. Dividend income takes no extra effort
The pandemic has led to significant job loss and economic devastation, but if you're lucky enough to remain employed as a member of the "reluctant remote workforce," you might have noticed more money in your bank account.
That's not simply a pleasant coincidence; there were significant costs required in having a job. Some of these costs can be reduced or eliminated (excessive office lunches and premium coffee), while others like commuting costs and professional clothing cannot.
But except for paying the initial share price, buying high-quality dividend stocks gives you a stream of income with no additional costs! In fact, brokers continue to cut the costs associated with their accounts and most now have commission-free trading.
3. Dividend income makes your life easier
Earned income is great, but not all the costs of getting it are easily observed. In fact, sometimes it's the indirect costs that are the most punitive. That's often the case in Corporate America, where the process to earn more income (aside from your annual salary increase, covered below) often requires you to work 60-hour weeks and take on more responsibility at your primary job, or embrace the "hustle culture" and take on a second job the minute you leave the office.
While ambition and drive should be applauded, there's a cost associated with working long hours. Studies have shown this can increase your stress level and lead to high blood pressure, back pain, and depression. This de facto "health tax" can eventually lead to more medical spending and worse life outcomes if not responsibly managed.
On the other hand, creating a stream of dividend income only requires you to buy high-quality stocks and hold them for the long term.
4. Dividend income grows faster and has been more reliable
There's been significant discussion about stagnant wages while the stock market continues to power higher. In the battle between capital and labor, capital is winning. Over the last decade, inflation-adjusted dividends from S&P 500 companies have increased by greater than 8% per year while payouts to annual wage income growth hasn't exceeded 4% in the same period.
Even among companies that are struggling, dividends remain a priority. For an example, look no further than oil giant ExxonMobil. Due to the pandemic's effects on travel, the demand and price for oil cratered and potentially put ExxonMobil's dividend at risk. Under this scenario, it was understandable if management paused dividend payouts until demand returned. It was a once-in-a-century global pandemic.
Instead, management did everything it could to reduce costs, cutting its workforce by nearly 15%, including nearly 2,000 U.S.-based employees. At the same time, it is maintaining its dividend (although it did not raise it for the first time in nearly two decades) and not ruling out taking on debt to pay the 8%-plus yield.
5. Reinvesting dividend income can have a double-compounding effect
Dividend income grows faster than you might think when you reinvest it, due to the powerful double-compounding effect. The first source of compound growth is that by reinvesting dividends back into the company, you will own more shares with every dividend payout and thus will be entitled to more dividends in the future. The second compounding source is that many companies are committed to growing their dividend payout every year.
On the second point, look for companies that are considered Dividend Aristocrats (denoting a company that has raised its dividend annually for at least 25 consecutive years), as they are committed to raising payouts for years to come.
Where to start?
If you're a new investor, remember that diversification is key. Even the best-run companies can suffer from external events, like a pandemic, that can impact their ability to pay investors. Luckily for you, there are a host of diversified exchange-traded funds that cater to dividend-loving investors.
Two ETFs to begin your research are the Vanguard Dividend Appreciation ETF (VIG 0.35%). This ETF seeks to invest in companies that have a history of growing their dividends, like Microsoft, Walmart, and Walt Disney. The downside is that the current yield of 1.6% is nothing to get excited about, but this is a pick for long-term holders looking to reinvest their dividends for the double-compounding effect.
If you're looking for a diversified portfolio of high-yielding stocks now, check out the Vanguard High Dividend Yield ETF (VYM 0.04%), which invests in large-cap stocks that pay above-average dividend yields. Large holdings in this ETF include stocks like Johnson & Johnson, JPMorgan Chase, and Verizon Communications, which allow the ETF to pay a yield of 3.25%.
Let 2021 be the year you start your journey to financial independence with the help of dividends.
