Dividend investing 101: What are dividends? How do they work?

• A dividend is a cash payment a company makes to its shareholders, typically on a quarterly basis.
• ETFs can offer diversified exposure to dividend-paying stocks, which may help balance growth and income objectives.
• Taxes matter — qualified dividends may be taxed at a more preferential rate than ordinary income.

A dividend is a payment made by a company to its shareholders, most commonly in the form of cash. Dividends are one way a company can choose to utilize profits generated through the normal operation of its business. These dividend payments reward investors who hold the company’s stock and may offer tax benefits in comparison to other potential sources of income in a portfolio.

Some companies pay higher dividends than others. Businesses that show financial maturity and stable cash flows tend to offer higher dividends than other companies. A consistent and/or growing dividend is one way investors can evaluate the health of a company.

Although U.S. dividend stocks have historically shown lower volatility¹ than the broader U.S. market, equity investing still carries risk, including the potential loss of principal.

Most companies announce dividends on a fixed schedule — usually quarterly for U.S. firms — after determining their earnings and financial position for that period. Cash dividend payments are typically declared in dollars per share of the stock. Let’s go over an example:

If an investor holds 100 shares of a company’s stock and receives a consistent quarterly dividend of $0.25 per share, they will receive $25 per quarter, or $100 each year.

Stocks may trade frequently, so determining who is entitled to a dividend payment is an important part of dividend mechanics. In the U.S., companies typically follow a rules-based and predictable method for paying dividends.

First, companies announce dividend distributions. Once this occurs, there is still time to buy or sell a stock to capture or avoid distribution. To receive the dividend payment, you must own the stock prior to the cutoff date known as the “ex-dividend date”. In other words, the ex-dividend date is the first date on which you can purchase the stock and not receive a dividend for that period. If you own the stock and sell prior to the ex-dividend date, you give up your right to the distribution.

Assuming no issues with the cutoff, dividend payments will be distributed to shareholders. Once the dividend is paid, investors can either enjoy the income or reinvest dividend payments back into the stock — most brokers provide a built-in option to automatically reinvest dividends if desired.

Dividend stocks may be particularly worth considering for investors who:

• Seek regular income
• Want potentially lower volatility than the broad market
• Aim to diversify sources of return
• Prefer companies with strong balance sheets

Dividend investing alone does not guarantee outperformance. Income is just one component of total return. The total return of a portfolio is based on both capital growth (price appreciation) as well as income. Bond ETFs, broad-market ETFs, and other income-seeking investments can complement dividend strategies — especially because diversification may help reduce risk during market downturns.

Exchange-traded funds (ETFs) offer convenience by allowing investors to gain access to a diversified portfolio of dividend stocks within one fund. ETFs can help investors achieve various portfolio outcomes such as income, growth, or capital preservation while providing superior diversification to single stocks. Diversification can help reduce an investor’s downside potential by spreading sources of return across a variety of companies, each with different characteristics and profit sources.

For example, the iShares Core Dividend Growth ETF (DGRO) offers exposure to approximately 400 U.S. stocks that have a history of consistently growing their dividends. The underlying index strategy not only looks at historical dividend growth but also targets companies that may be poised to continue growing their dividends over time, prioritizing long-term health over short-term gains.

To further diversify dividend exposure, investors may consider the iShares International Dividend Growth ETF (IGRO), which invests in dividend-paying companies from more than 30 countries worldwide and follows a similar dividend growth philosophy to DGRO.

Dividend stocks are distinct from other income strategies, such as bonds. Bond investing typically seeks predictable yield, also known as “fixed income”. Similarly to dividend stocks, investors may choose to pursue fixed income investing through diversified ETFs such as the iShares Flexible Income Active ETF (BINC).

While bonds tend to offer more predictable income than dividend stocks, their tax treatments differ. Bond interest is typically taxed at ordinary income tax rates, while dividends can be eligible for qualified dividend income (QDI) treatment. QDI is taxed at lower rates for most investors, which can benefit a portfolio’s after-tax return in taxable accounts. Importantly, not all dividends receive QDI treatment. ETFs such as DGRO and IGRO are managed to track indices that specifically screen for QDI eligibility.

Options-based ETFs are another way investors may choose to seek income. These ETFs, increasingly known as “premium” or “enhanced” income ETFs, can generate income through two primary sources: the sale of call options and the income generated by the underlying stocks or bonds.

One example of such an ETF is the iShares U.S. Large Cap Premium Income Active ETF (BALI), which invests in an actively managed portfolio of large-cap equities alongside writing call options. BALI can be used to seek income while maintaining upside potential and managing volatility.

For investors looking for additional portfolio diversification, the iShares Nasdaq Premium Income Active ETF (BALQ) also seeks options income but invests in stocks on the Nasdaq Stock Market, which tends to be tilted toward Technology and Communication Services companies.

Knowing when and where to use each kind of investment is critical to setting up your portfolio for long-term success. The table below breaks down key characteristics of dividend ETFs, premium income ETFs and bond ETFs:

As shown above, investors seeking income have a variety of options to choose from when constructing their portfolios. Each investor’s risk, return, and tax situation may be different, and investors should consult with a tax professional for personalized guidance. (Learn more about the potential tax advantages of ETFs)

Dividends are an important way companies share profits, offering investors income that may help support long-term financial goals. By using ETFs to access dividend-paying companies, investors can simplify diversification versus individual stocks, seek favorable tax treatment, and pair dividends with other income-producing strategies.