Dividend Stocks: How To Invest & 7 High-Yield Options for August

When the stock market is rocky, investors may want to consider stable investments that offer a regular stream of income. The best dividend stocks often provide both.

Top 7 high-dividend stocks this week

If you want to invest in dividend stocks, you'll need to have a brokerage account to do so. Brokerage accounts are free to open (though you'll have to deposit enough money to buy the stocks). It typically takes about 15 minutes to set up a brokerage account.

» Check out our roundup of the best online brokerages for dividend investing

What are the best dividend stocks?

The best dividend stocks are from well-established companies and increase their payouts over time. To pull the list of stocks in the table above, we focus primarily on dividend yield. But it's worth noting that the best options for you may not necessarily be the ones with the highest yield.

A high dividend yield can indicate many things, and not all of them are good. A falling stock price can actually increase dividend yields. Sometimes, companies overspend to pay high dividends and end up going into debt. The companies that overspend may eventually have to cut their dividends if they become unsustainable.

Your personal investment needs will likely determine which dividend stocks are right for you. For example, if you own lots of energy stocks, and you want to add some dividend-paying stocks, you may want to ensure that you're not adding even more energy stocks to your portfolio. The ideal portfolio varies from person to person, based on individual goals and timelines.

If you're looking for dividend stocks that likely won't cut their dividends, check out the dividend aristocrats. This is a group stocks listed on the S&P 500 that have increased their dividends every year for at least 25 years.

Dividend stocks vs. dividend funds

There are two main ways to invest in dividend stocks: Through funds — such as index funds or exchange-traded funds — that hold dividend stocks, or by purchasing individual dividend stocks.

Dividend funds offer investors access to a selection of dividend stocks within a single investment. That means with just one transaction, you can own a portfolio of dividend stocks. The fund will then pay you dividends on a regular basis, which you can take as income or reinvest. Dividend funds offer the benefit of instant diversification — if one stock held by the fund cuts or suspends its dividend, you can still rely on income from the others.

Whether it’s through dividend stocks or dividend funds, reinvesting those dividends can increase your return on investment. Dividends typically increase the return of a stock or dividend fund by a few percentage points. For example, the historical total annual return (which includes dividends) of the S&P 500 has been, on average, about two percentage points higher than the index's annual change in value.

And that difference can really add up: A $5,000 investment that grows at 6% annually for 20 years could become over $16,000. Bump that return up to 8% annually to include dividends, and that $5,000 could grow to over $24,000.

In general, a good rule of thumb is to invest the bulk of your portfolio in index funds or ETFs, for the above reasons. But investing in individual dividend stocks with a small portion of your portfolio can be beneficial.

Although it requires more work on the part of the investor — in the form of research into each stock to ensure it fits into your overall portfolio — investors who choose individual dividend stocks are able to build a custom portfolio that may offer a higher yield than a dividend fund. Expenses can also be lower with dividend stocks, since ETFs and index funds charge an annual expense ratio.

» Learn more about dividend ETFs

How to invest in dividend stocks

Building a portfolio of individual dividend stocks takes time and effort, but for many investors it's worth it. Here’s how to buy a dividend stock:

1. Find the dividend stocks you want to buy

You may already have a stock in mind, such as one of the high-dividend stocks listed above. But if you don't, you can look for stocks that pay dividends on your online broker's website. You can also check out free stock screeners.

2. Evaluate the stock

To look under the hood of a dividend stock, start by comparing the dividend yields among its peers. If a company’s dividend yield is much higher than that of similar companies, it could be a red flag. At the very least, it’s worth additional research into the company and the safety of the dividend.

Then look at the stock’s payout ratio, which tells you how much of the company’s income is going toward dividends. A payout ratio that is too high — generally above 80%, though it can vary by industry — means the company is putting a large percentage of its income into paying dividends. In some cases dividend payout ratios can top 100%, meaning the company may be going into debt to pay out dividends.

» Estimate your dividend stock returns with our dividend calculator.

3. Decide how much stock you want to buy

You’ll need to determine what percent of your portfolio goes into each stock. For example, if you’re buying 5 stocks, you could put 2% of your portfolio in each. However, if the stock is riskier, you might want to buy less of it and put more of your money toward safer choices. If you're going to reinvest your dividends, you'll need to recalculate your cost basis — the amount you originally paid to purchase the stock.

The number one consideration in buying a dividend stock is the safety of its dividend. Look carefully at dividend yields over 4%. Dividend yields over 10% tread firmly into risky territory. A too-high dividend yield can indicate the payout is unsustainable. It can also indicate that investors are selling the stock, driving down its share price and increasing the dividend yield as a result.

Another thing to keep in mind is that dividends in taxable brokerage accounts cause taxes to be realized in the year the dividends occur, unlike stocks that do not pay dividends whose taxation primarily occurs when the stock is sold. For investors with taxable accounts and in high income brackets, dividends stock might not be as tax efficient as other options.

» Need more detail? Learn how dividends are taxed