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- Dividend is a share of the profit earned by the company that is partly redistributed to the holders.
- An investor must be watchful of the company fundamentals before investing.
- Health of the company balance sheet is a very important consideration.
Stock market enthusiasts are often intrigued by the question as to whether it is possible to live off dividends. The short answer is, yes. The long answer, however, entails an investor’s understanding of the stock market, its volatility, future perception and, most of all, research skills. Considering that most, if not all, investors look for a comfortable retirement plan on the shoulders of dividend earnings, let us dive in to understand its inner workings.
What Is Dividend?
Investors who spend a lot of time on equity markets are fairly acquainted with the term dividend. But if we have to break it down to its simplest meaning, dividends can be defined as a part of its profit that a company shares with a class of its shareholders, the amount or frequency of which is decided by the management.
Dividends can be considered a company’s reward to its investors for pumping money into their business, as investing in a publicly traded company’s equities makes a shareholder involved in its risks.
Dividends can be paid in the form of cash or additional stocks depending on the situation and the decision-making body, which is usually the board of directors.
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Points To Remember Before Planning Dividend-Dependent Retirement
While it may not be a ridiculously impossible idea, a plan to live off of dividends in a post-retirement scenario may come with its own set of challenges, especially in a world after the COVID-19 crisis.
Keeping a steady flow of income is one of the major challenges of this plan. It should be noted that your capital investment should be prudent enough to allow you to live off of just your dividend income without touching your principal. Unless that is possible, it is wise to have a diversified source of retirement income.
Speaking of diversified sources, note that alternatives such as annuities or systematic withdrawals give a more upfront income than dividend, but they use up the principal. Dividends can generate a steady income stream while reserving the principal.
Another important factor that an investor should keep in mind is that a company that is doling out dividends has the power to reduce the amount or completely stop paying dividends at any given time, without any prior warning. Amid the pandemic, for example, many major companies resorted to snipping their dividend payout in efforts to control their costs.
When planning a dividend-based income, here are a few market and stock specific factors that an investor needs to consider:
- The stock’s dividend yield at the time of purchase.
- The company’s year-on-year income growth as reflected in the latest financial statements. This can be used to estimate the future prospects of dividend payment.
- A high debt-to-asset ratio is also a point to consider while investing in a dividend-paying stock.
- Monitoring the company’s balance sheet is important, as it is not wise to invest in companies with repeated decline in sales.
- The laws in your country regarding taxation on dividend income.
There is a substantial scope of benefitting from investing in well-researched dividend-paying stocks which reflect historical rising trends and robust financials. But investors, both novice and seasoned, should certainly remember to park their funds only after careful scrutiny and planning in order to live off of a steady dividend payment stream in the long run.