Investing in the stock market can be a powerful way to build wealth in the long term. But, did you know it’s possible to earn a dual income from investing by putting money in dividend stocks?

After reading this guide, you should have a better understanding of how dividends work and why people might choose to invest in them, as well as how you can invest in dividend stocks with Plum. And don’t worry, we’ve broken down the jargon for you so it’s more straightforward!

💡  Before we get started, it’s important to note that, as with all investing, your capital is at risk, which means the value of your investments can go down as well as up. This guide is not by any means financial advice by Plum. Please always conduct your own assessments and research and if necessary seek external advice.

What is a dividend?

Dividends are a distribution of a company’s earnings to shareholders. A small slice of the profits is paid to those who have invested in the business, with the number of dividends you get as a shareholder directly proportional to the number of shares you hold.

The company’s board of directors decides on the dividends to be distributed and they are usually paid in cash (although not always — we’ll get into it later), which is then deposited directly into the investor’s account.

When that company is doing financially well and making a profit, it has three options for the money it makes. It can:

  • use it for research and development projects
  • save it for other business expenses
  • return sums to shareholders as dividend payments.

Companies that choose the dividend method are likely to have reached their growth potential and no longer need to reinvest their profits back into the company. For example, over 80% of the companies in the S&P 500 Index pay dividends.

💡 The S&P 500 is a stock index that tracks 500 of the largest, publicly-traded companies in the US.

What does “dividend yield” mean?

You can find out how much a company pays in dividends by looking at its “dividend yield”. This is a stock’s annual dividend payments to shareholders expressed as a percentage of the stock’s current price.

The dividend yield gives you an indication of  how much you can expect to earn in future income from a stock based on the price you could buy it for today — assuming the dividend remains the same.

It can be difficult to visualise just exactly what all that means, so here’s an example for clarity:

If a company has a £100 share price and pays a dividend of £5 per year, its dividend yield would be 5%.

In simpler terms:

Dividend yield = Annual dividends per share / Price per share

💡 To check the dividend yield of a stock in Plum, find the “dividend stock” collection, tap any stock within the collection and voila. You’ll see the current dividend yield expressed as a percentage. Dividend yields may change daily as the prices of shares that pay dividends rise or fall.

What is a "good" dividend yield?

What's good for one person might not be positive for another. But generally speaking, a high yield dividend is anything offering 3% or more, depending on the state of the economy.

That’s not to say all high-yield stocks are good investments. In fact, it’s recommended to be wary of stocks that pay out significantly more than 3%. It could indicate risky management, falling share price or a company that’s economically unsustainable in the long term. This is why doing your research is so important!

When choosing dividend stocks, it’s important to look for a company that offers dividend stability as well as good business prospects. You should also consider whether investing is the right option for you bearing in mind your current position and financial situation. Never underestimate how the market values can change or fluctuations in prices and returns may differ from one day to another.

Why do some companies pay dividends?

Not all businesses choose to go down the dividend path, but those that do, normally do it for two main reasons:

To attract investors

Paying out regular dividends can appeal to a certain type of investor who is seeking stocks as a way to earn a passive income.

Dividends are especially attractive during a bear market, as they can help counteract a market downturn and make it easier to hold stocks over time.

💡 A bear market happens when the stock market experiences a prolonged decline in stock prices.

To share out profits

Dividends can also work in the same way as an old-fashioned rewards system. Companies pay them out to thank investors and encourage long-term loyalty.

Of course, for a company to share profits with investors, they need to actually turn a profit. Dividends are therefore most commonly distributed by well-established companies that generate consistent revenue.

What are the different types of dividends?

1. Cash dividends

Cash dividends are by far the most popular type of dividend payment used. This dividend is paid in cash against the number of shares you own.

2. Stock dividends

Stock dividends are paid to shareholders by issuing them new shares in the company. These are paid out based on the number of shares the investor already owns.

3. Scrip dividends

When a company doesn’t have the funds to issue dividends in the near future, it might issue scrip dividends. These are essentially a promissory note (IOU) that promises to pay shareholders at a later date.

4. Property dividends

Although not common, companies can choose to pay dividends by giving assets/inventories to shareholders instead of cash.

5. Liquidating dividends

Liquidating dividends are paid to shareholders during partial or full liquidation. The company returns the amount that shareholders originally invested, and it is not usually taxed.

💡 Note that there are a number of laws that govern the distribution of dividends and the types of dividends available.  The board of directors may have discretion under a company's articles of association to decline a payment. Always review your contracts and seek advice if you're not sure which type of dividend is suitable for your financial circumstances.

How much tax do you pay on dividends?

You get a dividend allowance each tax year in the UK. The dividend allowance for 2022/23 was £2,000, which means that you didn’t have to pay tax on the first £2,000 you earned from dividends.

However, Chancellor Jeremy Hunt announced in his Autumn Statement on 17th November 2022 that he will be slashing this allowance to £1,000 in 2023/24 and £500 in 2024/25.

How much tax you pay on dividends above the dividend allowance depends on your income tax band.

You can read all about dividend taxes on the government website.

If you have a Stocks & Shares ISA, your dividends are safe from tax, provided you follow the ISA limits and rules, which you can learn more about in our ISA guide.

How often are dividends paid in the UK?

In most cases, dividends are paid four times a year, every quarter. Some companies might choose to pay dividends monthly, but it’s ultimately determined by each company’s board of directors and its constitutional documents.

Here are some key dates you might hear about when researching dividends:

  • A declaration date is the date when a company announces it will distribute dividends to investors.
  • An ex-dividend date (or “ex-date”) is the deadline for dividend payouts to existing shareholders. In other words, the company must pay dividends to the shareholders who buy the stock before that date. If you buy on or after this date, the company doesn’t owe you dividends.
  • The payment date is when the dividends are finally paid out.

Do you get dividends for owning fractional shares?

Yes. If you own fractional shares (pieces of a whole share), you’re still entitled to receive dividends in proportion to the fraction you own. If you own half a share, you’d get half of the dividend per share paid out.

What are the benefits of buying dividend stocks vs regular stocks?

Dividends provide another stream of potential income

One of the main reasons people invest in dividend stocks is because they can provide a steady source of income in the future, like interest from a savings account but with one vital difference: your money is at risk when you invest in the stock market. So your money can go up as well as down.

Some companies that distribute dividends consistently and periodically give investors a “guaranteed” source of money.

You can reinvest the dividends

If you use your dividends to buy more shares, and then use the dividends from these new shares to buy even more, the dividends will compound. This will hopefully create a cycle of greater investments and greater returns.

But always remember that you should track compounding risks, potential impacts and interactions, to avoid making any bad decisions or finding yourself at financial risk.

💡 Compounding is the process of reinvesting the earnings made from an asset, in this case from dividends, to generate additional earnings over time.

Here’s what dividend reinvestment could look like in the long term:

Source: The College Investor.

The above graph is based on a portfolio with a 3% dividend yield and a 7% dividend growth rate. It’s purely an example to show the potential effects of dividend reinvestment.

However, it’s important to note that nothing is guaranteed when it comes to investing, and past performance is not a reliable indicator of future results.

So although stocks and shares historically outperformed money in savings accounts, there’s no guarantee they will in the future.

How can I invest in dividend stocks?

There are two ways to invest in dividend stocks. You can either choose a particular stock to invest in directly or buy a group of dividend stocks as part of a fund. Regardless of which option you choose, Plum - although it does not provide financial advice -  can help you get started.

1. Choosing dividend stocks

After logging in and heading to the investment section of the Plum app, you can explore various collections of stocks, one of which is “3% dividend yield stocks”.

These are high dividend stocks, through which you could earn dividend income. By tapping a specific stock, you can also find valuable information about it that you should review carefully, including its past performance, dividend yield, price-to-earnings ratio and company summary to help you make an informed decision before investing.

2. Investing in a fund

Investing in stock can be daunting, especially if you’re a first-time investor. There’s so much choice and investing in just one company could mean your portfolio isn’t diversified.

Diversification is important for mitigating risk. It basically means not putting all your eggs in one basket... Or one investment. If you invest in one stock and the company goes bust, you lose your money. Of course, diversification entails risks as well so make sure you conduct — as always — your research!

Funds, on the other hand, are diversified collections of different stocks. By buying one share in a fund, you can get fractional shares of many different companies, spreading your risk.

With Plum, you can invest in funds that specialise in dividend stocks, including:

  • Growth Stack: Vanguard’s Life Strategy 80% Equity Fund
  • Global Dividends: M&G Global Dividend Fund Sterling
  • UK Dividends: Franklin UK Rising Dividends Fund
  • Rising Stars: Vanguard Global Emerging Markets Fund.

Start your investment journey with Plum

Plum’s making dividend investing more accessible. You can invest in funds and shares with as little as £1. After you choose which dividend stock you want to invest in, we’ll send you a notification whenever you receive your dividend so you can keep track of any income.

The dividend will be paid directly into your Plum account as cash. And what you do with that cash is up to you. You can reinvest it, save it or even spend it.

The opinions expressed in this article are for general informational purposes only and should be used at your own risk. It’s your responsibility to evaluate the accuracy, timeliness and completeness of any information provided.

Plum does not provide investment or other advice so individual investors should make their own decisions or seek independent advice. If you invest, please remember that your capital is at risk and you could lose money. The value of your investments can go down as well as up.

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