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Before you “look for dividends,” here’s what you need to know

Increasing fears of a possible recession, investors looking for a stable income may turn to shares that pay quarterly dividends, which are part of the profits of companies that return to investors.

Historically, dividends have significantly contributed to the overall return on an asset, sometimes giving a boost in economic downturns.

From 1973 to 2021, companies that paid dividends achieved a total annual return of 9.6%, averaging 8.2% of the S&P 500 index, and a return of 4.79% of those who did not pay dividends, according to a 2022 Hartford Funds study.

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Dividends have the attention of investors: dividend funds have added $ 43 billion in 2022 since the end of June, according to the SPDR Americas study.

However, investors need to consider their options before adding dividend payers to their portfolios.

“People sometimes look for dividends and don’t understand the risks,” said Scott Bishop, certified financial planner, executive director of wealth solutions at Avidian Wealth Solutions in Houston.

Here’s what you need to know.

Why are dividends attractive in tough economic times

“Companies that pay dividends will typically have a higher level of free cash flow,” said Dave Sekera, Morningstar’s chief U.S. market strategist. And they may be valued more modestly, he said.

“Both have been attractive to investors this year as we see the economy softening, interest rates rising and inflation still heating up,” Sekera said.

Dividend payers tend to be large, mature companies that produce products and services that are still needed in recession by Kashif Ahmed, president and president of the CFP of the American Private Wealth in Bedford, Massachusetts.

“No one needs a Rolex every day, but we all need toilet paper,” he said.

Some companies, known as “dividend aristocrats,” have a history of increasing dividends every year, even in previous recessions. And many companies are slow to reduce dividends, offering some investors a reliable cash flow.

Be critical when looking for high dividend yields

While higher dividend payments may be attractive in a flat or declining market, it’s important to value what you’re buying before adding new assets to your portfolio. Bishop noted that there may be risks.

A company’s dividend yield is divided into two parts: the annual dividend per share and the current share price, Bishop explained. If the dividend yield is above similar companies, the share price may have fallen for a number of reasons.

People sometimes look for dividends and don’t understand the risks.

Scott Bishop

Executive Director of Wealth Solutions at Avidian Wealth Solutions

“You don’t just have to look at the dividend yield,” Bishop said, explaining why understanding the company’s finances is essential.

And for those who don’t want to look at each company, dividend-paying funds can offer greater diversification than individual stocks.

Keep dividend payers in tax accounts

Whether you receive income from stocks or bonds, you need to be strategic about what type of account you use to store those assets, Ahmed explained, especially if you are an investor with a higher tax level.

In general, it is better to generate income-generating assets, such as shares that pay dividends, mutual funds with annual payments, or bond coupons, such as in tax-subsidized accounts, 401 (k) or in an individual retirement account, he said. Alternatively, you may owe capital gains taxes.

Before you “look for dividends,” here’s what you need to know

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