In a well-diversified portfolio, you normally have three different type of earnings — appreciation, dividends, or interest. “Appreciation” is the growth in the value of your investment based on the market going up. Income investors receive “dividends” or “interest” on their investments.

INTEREST

Interest is what you earn on money you lend out. For example, when you buy a corporate bond, you lend money to a company. When you buy a Treasury bond, you lend money to the U.S. government. These issuers then pay you interest, normally once every six months. When the bond matures, they pay you back the original value of the loan.

DIVIDENDS

Dividends allow you to share in the profits of a company. As companies have more predictable income streams, they may choose to share a portion of their revenues with the owners of the firm – the stockholders. Dividend payouts normally get distributed quarterly.

WHAT IS THE DIFFERENCE BETWEEN INTEREST AND DIVIDENDS?

Interest payments are contractual obligations of the issuers, and bondholders can feel confident that as long as the company or government that issued the bond doesn’t default, they will get their interest payments on time. Dividends, on the other hand, can change, and are not guaranteed. It is possible for a company facing a decline in profits to slash, suspend, or delay a dividend.

Interest and dividends, and capital gains for that matter are each taxed differently in the United States. And if you live in Israel, you’ll have other taxes to consider. Speak with an accountant to understand your specific situation.

INTEREST RATE LIFT-OFF

As current interest rates are near historic lows, some people are hoping that the U.S. Federal Reserve will raise interest rates. Interest-paying bonds will be hurt, as investors are locked into lower rate returns. Dividend-paying stocks can also be affected.

An interest rate hike could change the risk-return profile of your investment portfolio. If bond prices fall, for example, and your bond allocation decreases, you might need to rebalance.