Ah, dividends. Is there any sweeter (virtual) sound than the digital tinkling of dividends as they fall into your bank account every six months or so?
Dividends – like rent, but to a greater degree – are the true expression of "passive income". You don't have to stand at the tills, dig the pit, code the software or restock the ATMs; as a business' part-owner, someone else is doing that for you.
![Former prime minister and treasurer Paul Keating was the architect of superannuation and the dividend imputation system.](http://web.archive.org./web/20170730155620im_/https://www.fairfaxstatic.com.au/content/dam/images/g/x/1/m/5/l/image.related.articleLeadwide.620x349.gxju0z.png/1501170144713.jpg)
Which doesn't mean dividends don't come as the result of hard work, by the way – you had to work and save hard to put aside your investment dollars in the first place. But, once that investment is made, you stand ready to collect your share of the company's profits by way of dividends.
Even better, dividends are about the most concessionally taxed income you can earn. Indeed, if you're in a low-enough tax bracket, or you're a retiree with a super fund in pension phase, the Tax Office may actually send you extra money each year. You won't get that from cash in the bank or an investment property.
And dividend season is about to start in earnest, so let's make sure you're ready.
Start now
Just like nothing should be done purely for tax reasons, you shouldn't invest in dividend-paying shares solely for the dividends. But if you're going to start investing, or you're already invested, but you're thinking about making some changes, you'll want to do it in the next few weeks so you don't miss out on those dividends.
Be like Frank
Okay, Frank isn't a real person, but fully franked dividends are real all right. All else being equal (it rarely is, but work with me here) the tax benefits of fully-franked dividends beat the pants off unfranked dividends, because the former comes with a nice little kicker from the Tax Office in the form of lower tax rate, and, in some cases, a refund.
If it seems to good to be true …
… it probably is. There has been no shortage of attractive-looking dividend yields that ended up being a mirage. Remember when people – briefly – talked about BHP as an income stock because it hadn't yet cut its dividend? Well, surprise: it did cut the payout. Last year's dividend doesn't matter – only this year's. Buy companies whose expected profits will more than cover the dividend you're hoping for.
Don't believe the hype
There are two traps that some sections of the finance community persist in not just ignoring, but actively promoting. The first is "3 dividends in 13 months", which, while technically true is the same as saying I get three fortnights' pay in four weeks and one day. It's strictly true, but doesn't allow for the fact you got nothing for the 13 days either side of those 29 days!
And the other? Remember that share prices will usually fall after the dividend entitlement date. Which makes sense: if I have $1000 and offer you $100, you're not going to pay $1000 for the $900 left in my bank account, are you? So dividends aren't a free lunch.
Foolish takeaway
Regardless of your political persuasion, investors have a lot to thank Paul Keating for: notably superannuation and the dividend imputation system we know as franking. And, invested well, your nest egg will pay you a nice, tax-effective dividend stream twice a year, which will likely even rise over time, as your companies increase their profits.
Just remember not to make tax the driving force.
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Scott Phillips is the Motley Fool's director of research. You can follow Scott on Twitter @TMFScottP or email ScottTheFool@gmail.com. The Motley Fool's purpose is to educate, amuse and enrich investors.