What dividends are, what yield really tells you, and how much capital a given income takes
A dividend is a share of a company's profits paid to shareholders, usually every quarter. Dividend income comes from owning shares or funds that pay them. It is one of the few kinds of income that needs no ongoing work, but it needs capital, and the amount it pays depends on that capital far more than on which stock you pick.
Dividend yield is the annual dividend divided by the share price. A $100 share paying $4 a year yields 4%. When a share price falls sharply the yield rises on paper, often just before the company cuts the dividend, so an unusually high yield is a reason to check the company's earnings and payout ratio rather than a reason to buy.
At a 3% yield, $10,000 pays about $300 a year; $100,000 pays about $3,000, or $250 a month. Reinvesting dividends buys more shares, so the income grows over time if the companies keep paying — but dividends can be cut, and share prices can fall at the same time.
Qualified dividends — generally from U.S. companies whose shares you have held more than 60 days around the dividend date — are taxed at the long-term capital gains rates of 0%, 15% or 20%. Other dividends, including most REIT distributions, are taxed as ordinary income. Higher earners may also owe the 3.8% net investment income tax. You receive a Form 1099-DIV each year.
Chasing yield, concentrating in a handful of dividend stocks or one sector, and forgetting total return: a fund that pays a high dividend but loses value can leave you worse off than a lower-yielding one that grows. A broad, low-cost fund is the usual starting point.
See also: Portfolio Income, Active Income and Capital Gains.
$1,200 a year ÷ the yield. At 3% that is $40,000; at 4%, $30,000.
In everyday language, yes — they need no ongoing work. For tax purposes the IRS classes them as portfolio income, not passive income.
Tax rules, limits and pay data change. Check the current figures with the primary source before acting on them.