Let’s learn more about interest vs dividends and why both are important in the personal finance niche. Both can be considered passive income and create substantial cash flow with a considerable amount invested. On the other hand, both have lower barriers to entry and may not involve a lot of capital to get started.
Look at Bookmark Investor’s most recent post if you are interested in reading about passive income. Let’s dive in to see what dividends are, where an investor can earn them, what interest is and how an investor can earn interest.
Feel free to read more into the sources used to find additional in-depth explanations for these questions. This article gives concise context behind earning dividends and/or interest as investment opportunities.
What are Dividends?
Dividends are cash payments paid to shareholders who invest in companies or ETFs. Investopedia defines dividends as a “distribution of a company’s earnings to its shareholders…” There are plenty of companies that trade on the market that payout dividends. You can see this information on most financial data websites like Yahoo Finance or your brokerage.
It is important to research companies’ financial information and try to gauge their financial health during the current period. A company’s future can’t be predicted, so measuring risk can be significant in deciding on a prospective investment. Dividends are paid out from earnings; one of the numerous ratios that an investor can analyze is the payout ratio. To summarize, a payout ratio is a percentage a company distributes dividends to shareholders from the total amount of earnings. You can also learn more about a good or lousy payout ratio here.
One ratio isn’t a huge deciding factor in making an investment decision, so doing more due diligence can be helpful.
Why invest in dividends? An investor can build an income stream with enough capital invested and research finding good-paying dividend companies. With time and compounding, this income stream can potentially cover living expenses and even create a surplus to save or invest more.
Reinvesting the dividends back into the company using a DRIP (dividend reinvestment program) can help the money initially invested compound by buying fractional shares. Investors can earn dividends from their dividends and initial capital invested. Check out this example of how dividends can help you compound your money for a greater return.
Where Investors Can Earn Dividends
Investors can earn dividends by buying dividend stocks or ETFs that pay dividends to shareholders. Brokerages like Robinhood, Fidelity, or TD Ameritrade allow investors to buy and trade stocks, ETFs, and options. Investors can buy and hold these stocks or ETFs in their brokerage accounts.
When dividends are paid out, investors can see the amount in their recent transactions on most brokerage platforms. Companies pay out dividends monthly, quarterly, or annually. The frequency and timing depend on the company. Read more about how dates work with dividend stocks. In short, look out for the ex-dividend date to determine when the cut-off is to buy a stock and earn the dividends that quarter or month.
There are plenty of strategies investors use to buy dividend stocks, one called dividend growth investing. This strategy involves investing in companies that continue to grow their dividends over time and can increase an investor’s income. The increase in income comes from 1) the dividends compounding and 2) the dividends growing. Both are ways dividend investing can be effective in the long run.
What is Interest?
Let’s learn more about what interest is in the form of income. Interest can be earned or paid. Regarding interest as income, you can read more about the actual definition on Bankrate’s page. In short, an investor can make interest from investing money into an account that pays interest. Interest rates fluctuate and can change depending on various factors.
Why do interest rates fluctuate? Interest rates are volatile and can change for various reasons. Economic conditions, monetary policy, and other factors affecting our financial markets can all be reasons for the volatility in interest rates.
Where Investors Can Earn Interest
Investors interested in earning interest income can research high-yield savings accounts or CDs (Certificate of Deposits). Banks have information about these financial products on their websites, where they update interest rates and other details behind their products. These interest rates can change, so doing research can be an important factor in the process.
The benefits of high-yield savings accounts are that they usually offer a higher rate than a standard savings account. Keeping money in a lower-yielding savings account could be considered an opportunity cost if an investor found another account that offers a higher rate. Alternative investments may provide or have the potential for a higher return. On the other hand, these high-yield savings accounts may be safer than those alternative investments.
Setting up a high-yield savings account can be relatively easy, most banks have instructions on their websites, or you can contact their customer service lines. Helpful things to look out for are FAQ sections on their pages, FDIC membership, and if they have user-friendly platforms.
Conclusion: Interest vs Dividends
Investing in dividends or savings accounts that offer interest are great ways to earn income passively. Which one to pick may depend on preference and how much time someone wants to research prospective investment opportunities. Other factors include risk tolerance, market fluctuations, economic conditions, and opportunity cost, which can also affect which route to take.
Dividend investing may involve heavy research, risk, patience, and an understanding of market conditions. Another way dividend investing can provide a return is if the stock or ETF appreciates. Capital appreciation and dividend income are both ways to make a return on investment when investing in dividend-paying stocks.
Investing in high-yield savings accounts or CDs may have more volatility in returns but can be a slightly less risky way to earn income on liquid cash an investor has saved.
Both can be ways to diversify investments and bring in more income to an investor’s portfolio.
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