Cents and Sensibility
Dividends have a tax benefit, but they still carry risks
IF you found a stock that had risen in value every year for 25 straight years, you'd probably think you had a great investment prospect. Unfortunately, you'd have a tough time locating that stock. On the other hand, with just a little research, you can find many stocks that have increased their dividends for 25 or more consecutive years -- and dividends can be quite valuable to you.
You can now find dividend-paying stocks in a wide variety of industries, including financial services, food producers, consumer products, pharmaceuticals, technology, publishing and others. In short, you can help diversify your portfolio by investing in dividend-paying stocks -- and many of them offer growth potential, too.
(Keep in mind, though, that stocks are not fixed-income vehicles, and they may not always pay out dividends, no matter how good their track record has been.)
At some point in your life, perhaps when you are retired, you may need to use your dividend checks to help boost your cash flow. But when you are still working, you might find it to your advantage to reinvest the dividends back into the stocks you own. And since most stocks will offer automatic dividend reinvestment plans, you don't have to do a thing to boost your ownership stake.
Up until a few years ago, dividends were taxed at your personal income tax rate. But the tax laws have changed. Now, you'll pay a maximum of 15 percent on dividends.
Clearly, this new rate will affect your decision-making on how to receive investment income. Dividends may now be more attractive, from a tax standpoint, than bonds and certificates of deposit. Both bonds and CDs pay interest that is taxed at your current income tax rate, which could be as high as 35 percent. But you'll need to balance this tax advantage with the greater investment risk carried by stocks. Any investment-grade bond likely will offer you greater protection of principal than even the most stable of stocks. On the other hand, fixed-income investments expose you to purchasing power risk if their return does not keep up with inflation.
Ultimately, there's no easy answer to the question of how you should structure your portfolio to receive investment income. You're probably better off by diversifying your holdings to include both dividend-paying stocks and bonds, along with growth stocks, government securities and other types of investments.
The 15 percent rate on dividends is scheduled to expire on Dec. 31, 2008; after that, dividends will again be taxed at your personal tax rate, unless Congress acts to make the 15 percent rate permanent. So, stay informed on what's happening in Washington -- it could have a significant impact on your investment plans.
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Guy Steele is a financial planner and head of the Pali Palms office of Edward Jones. Send planning and investing questions to him at 970
N. Kalaheo Ave., Suite C-210, Kailua, Hawaii, 96734,
or call 254-0688