How a dividend works
When a company makes a profit it can reinvest the money, buy back its own shares, or pay some of it to shareholders. That payment is the dividend. If a share costs 100 and pays 4 a year, the yield is 4%.
The yield moves in the opposite direction to the price. If the share falls to 50 and the dividend stays at 4, the yield becomes 8%. That is why a very high yield often means investors expect the dividend to be cut.
Can the company afford it?
The payout ratio is the share of profit paid out as dividends. A company paying out 40% of its profit has room to keep paying in a bad year. A company paying out more than it earns is funding the dividend from savings or borrowing, which cannot last.
A record of raising the dividend for ten, twenty or more years in a row shows that the business has kept generating cash through several downturns. In the US, companies in the S&P 500 that have raised their dividend for at least 25 consecutive years are known as Dividend Aristocrats.
Income now or growth later
A portfolio of high yielders pays more today but tends to grow slowly. A portfolio of dividend growers pays less at first, with payments that rise over time. Many investors mix the two.
If you do not need the income yet, reinvesting dividends buys more shares, which pay more dividends. Over long periods that compounding accounts for a large part of total returns.
Tax and practicalities
Dividends are often taxed differently from other income, and dividends from overseas companies may have tax taken off before you receive them. Tax-sheltered accounts, such as a Stocks and Shares ISA in the UK, can remove some or all of that. The rules depend on your country and can change, so check the current position for your circumstances.
Types of dividend company
Dividend growers
Pay a modest dividend but raise it year after year.
For example: Microsoft, Visa, Procter & Gamble
Steady payers
Mature businesses with reliable cash flow and a mid-range yield.
For example: Johnson & Johnson, Coca-Cola, Unilever
High yielders
Pay out a large share of profit. Income is high, growth is usually low.
For example: Large tobacco, telecoms and energy companies
Property companies (REITs)
Own property and are required to pay out most of their rental profit.
For example: Realty Income, Segro
Companies are listed to show what each category means. They are not recommendations, and the list is not complete.
Three ways to invest
There is no single right route. Many people combine them, and plenty decide a broad global fund is all they need.
- 1
Buy individual shares
Pick one or more dividend-paying companies and buy their shares through a broker or investing app.
- Good for
- Simple to understand. You own exactly what you chose.
- Watch out for
- If you only hold a few companies, one bad result can do real damage. Picking winners is hard, even for professionals.
- 2
Buy a ready-made fund
A fund (often an ETF) holds dozens of companies in one purchase. Examples include the Vanguard Dividend Appreciation ETF (VIG) and Schwab U.S. Dividend Equity ETF (SCHD) in the US, and the Vanguard FTSE All-World High Dividend Yield UCITS ETF (VHYL) in the UK and Europe.
- Good for
- Instant spread across many companies, with very little effort.
- Watch out for
- You get what the fund provider chose, including companies you may not want. Themed funds usually charge more than broad trackers, so check the yearly fee and the top ten holdings. Which funds you can buy depends on where you live.
- 3
Build your own portfolio
Choose your own mix of companies and how much of each, then buy them through your broker. This is what Arithmos helps with: describe the mix in a sentence and it builds and tests one for you to consider.
- Good for
- You decide exactly what is in and what is out, and you can see the reason for every company.
- Watch out for
- More to look after than a fund. Buying many separate shares can cost more in dealing fees, and a tested result is a simulation, not a promise.
The risks
- Dividend cuts. Payments can be reduced or stopped, and the share price usually falls at the same time.
- Yield traps. An unusually high yield can signal a business in trouble.
- Sector concentration. High-yield portfolios lean heavily towards a few industries, such as energy, banks, tobacco and utilities.
- Interest rates. When savings accounts and bonds pay more, dividend shares can become less attractive and fall in price.
- Lower growth. Companies that pay out most of their profit have less to reinvest.
Try it yourself
The quickest way to understand a portfolio is to look at one. Here is how to turn this guide into something you can inspect.
- 1
Start from the idea
The button below opens the builder with this guide's idea already typed in. Change any part of it: the number of companies, the countries, the limit per company.
- 2
Read the reason for every company
You get a list of companies, how much of each, and a plain-English reason for each pick. If one looks wrong to you, you can ask for it to be changed.
- 3
Look at the bad years, not just the good ones
The portfolio is replayed against real past prices. Check the biggest fall along the way, and ask yourself whether you could have sat through it.
- 4
Decide for yourself
If you want to act on it, you buy the shares yourself through your own broker. Arithmos never holds your money or places trades.
“Large US and UK companies that have raised their dividend every year for at least 10 years and pay at least 2.5% a year. 25 companies in equal amounts.”
Browsing portfolios other people have published is free. See pricing for what building your own includes. A tested result is a simulation using past prices. It is not a forecast and not a recommendation.
Common questions
What is a good dividend yield?
There is no single answer. Broad stock markets have typically yielded a few percent. A yield far above that deserves a closer look at whether the company can keep paying it.
Are dividends guaranteed?
No. A company's board decides each payment and can reduce or cancel it at any time.
Should I choose high yield or dividend growth?
It depends on whether you need income now and how long you plan to invest. This is a personal decision that Arithmos cannot make for you. The guide above explains the trade-off.
