One popular way of investing is putting funds into companies that pay dividends. Some of these companies pay a return that is as high as 7-8%. As global financial markets continue to be volatile, investors are searching for ways to enjoy growth in their portfolios while lowering the volatility usually associated with such growth. But what are dividends, and how can they help your investment portfolio?

What Are Dividends?

Dividends are the share of a company’s profits that it decides to pay to its shareholders.  They are an important part of the return that an investor receives from investing in shares, in addition to any increase in the share price.  Although companies are under no obligation to pay dividends, they usually choose to do so because dividends provide an incentive to invest in their shares. 

When a stock pays an 8% dividend yield, what does this actually mean? If a certain company is trading at $25 a share, and it distributes $2 a share in dividends, if this dividend is divided into the price of the stock, the investor receives 8%. This yield changes according to the price of the stock and the amount of money that the company decides to allocate. In the example given above, if the share price were to drop to $20 the dividend yield would be 10%. Conversely, if the price of the stock would move up to $50, the yield would be 4%.

How Do They Help?

Much research has been done on the impact of dividend investing versus non-dividend investing over the past 30 years. According to Ned Davis research, from January 1972 through 2005, the companies in the S&P 500 index that paid a dividend returned over 10% annually, while the non-payers returned a lowly 4.1% annually. Over time, more than 65% of the return on stocks has come from the compounding of reinvested dividends. Dividend-paying stocks tend to be less volatile than the non-payers because the dividend acts as an extra cushion in falling markets. Keep in mind, past performance is no guarantee of future returns.

Too Good to be True?

With all this in mind, it is still important to be careful when deciding whether to invest in a dividend-paying stock. When a certain company has a dividend yield of 15%, this may sound very attractive. However, a key factor to note is whether the company will be able to continue to pay or even increase the amount of the distribution. Historically, companies that cut the amount of money they distribute have very poor performance going forward.

Dividend Downside

On the other hand, many investors don’t like it when companies pay out dividends because they prefer that the available cash is reinvested in the company, growing its profitability.  Other investors say that if the company is in debt, some of the available cash should go into reducing or eliminating it. This school of thought is similar to what we learn in home economics. If a household is in debt, and suddenly the family comes into a large sum of money, all of its debts, loans and overdrafts should be paid off. It is better to use the opportunity to have a clean slate, rather than spending the newfound money on a vacation or other luxuries.

If you are considering investing in dividend-paying stocks, speak with your financial adviser to find out if it is appropriate for you.

The S&P 500 index measures Large-cap stocks in the US and stock market performance of leading companies in leading industries. An investor cannot invest directly in an index.

Aaron Katsman is Managing Editor of the Israel Opportunity Investor newsletter. He is lead portfolio manager for the Israel Growth Portfolio and Managing Director of America Israel Investment Associates, LLC. For more information, go to www.israelnewsletter.com or call 1-888-327-6179, or email aaron@profile-financial.com.

With the continued weakness in global financial markets there is a good chance that even though the value of your portfolio has dropped, you still maybe able to profit. As the old saying goes, there are only two certainties in life: death and taxes. While no one can say they have solved the certainty of death, there are ways to make your portfolio more tax efficient, and thus help lower your tax bill.

When reviewing prospective client portfolios, especially in the current market environment, every now and then we come upon a stock that is trading at a lower price than it was acquired at. When I advise the client to sell the stock and at least use the loss to offset other gains that have been generated in the portfolio, I am often met with a firm NO! The client says that he believes that the stock will go back up and he wants top wait to sell it. The are two faults with this answer. First, the stock hasn’t been a stellar performer until this point, what is to make you think that it will start going up. Secondly, there may be another way to profit from the poorly performing stock.

Tax-Loss Selling

When one decides to sell the positions at a loss in the portfolio, the term used is tax-loss selling. It’s a process of selling securities at a loss to offset a capital-gains tax liability. It is typically used to limit the recognition of short-term capital gains, which are normally taxed at higher federal income-tax rates than long-term capital gains.

Though they may not realize it, for many investors, tax -loss selling may be the most important way to reduce your tax bill. If done correctly, it can save you money and help you diversify your portfolio in ways you may not have considered.   For example, Let’s say you have a gain in Stock A and you decide to sell it. You will be taxed on that gain in full. But if you have a loss in Stock B and you actualize it by selling, you can use the amount of the loss and offset it against the gain, thus, drastically reducing your taxes owed. You wont be able to recover the whole loss you suffer but it certainly cushions the blow.

Why wait

It’s customary for both professional money managers and investment advisors to wait until the end of the year to start selling their losing stocks. But there are no hard and fast rules as to this. Personally, I like to take advantage of downturns in the market, like we have now, to review clients’ portfolio and advise on taking losses. Keep in mind one of the golden rules of investing, to ride your winners. Some of the most successful investment strategies call for investors to hold on to their good performing stocks and sell the laggards, because chances are there is a good reason that they are lagging. After what we have already mentioned, there is and added value of selling the laggards, you get to use those losses to offset the gains you may have. So not only do you make your portfolio current, by holding only the good positions, but you can benefit financially as well by realizing the losses.

Be Careful

There is a rule in the US, called the Wash-sale rule, where the IRS disallows a loss deduction from the sale of a security if a ‘substantially identical security’ was purchased within 30 days before or after the sale. Let’s say that you bought 100 shares of General Electric March 1st and then sold 100 shares of GE on March 15 at a loss, the loss deduction would not be allowed .The wash-sale rule is designed to prevent investors from making trades for the sole purpose of avoiding taxes.

Speak with The Professionals

It’s important to speak with your accountant before implementing this tax loss strategy. Many times your accountant will work closely with your investment advisor in order to best serve your needs. The accountant will also be knowledgeable about any local tax implications, and can help you plan accordingly.