Dividend Investing
A dividend is a payment a company makes to its shareholders, usually in cash and usually from profits. Many mature companies pay dividends every quarter, while many fast-growing companies pay none and reinvest their earnings instead. Dividend investing focuses on companies or funds that pay regular, ideally growing, dividends.
Key terms
- Dividend yield is the annual dividend per share divided by the share price. A stock that pays $2 a year and trades at $50 yields 4%.
- Payout ratio is the share of earnings paid out as dividends. A very high ratio can leave little room for the company to keep paying if profits fall.
- Dividend growth refers to how consistently a company has raised its payment over time.
The important dates
- Declaration date: the board announces the dividend amount and dates.
- Ex-dividend date: you must own the stock before this date to receive the payment. If you buy on or after it, the seller gets the dividend.
- Record date: the company checks its records to see who the shareholders are.
- Payment date: the dividend is paid.
A stock's price typically drops by roughly the amount of the dividend on the ex-dividend date, so buying just before that date to "capture" a dividend is not free money.
Reinvesting dividends
Many brokers let you reinvest dividends automatically in more shares of the same stock or fund, often in fractional amounts. Company-run dividend reinvestment plans (DRIPs) do the same. Reinvesting lets dividends compound over time. Reinvested dividends are still taxable in a regular brokerage account in the year they are paid.
How dividends are taxed
In a taxable account, qualified dividends are taxed at the lower long-term capital gains rates, while ordinary (nonqualified) dividends are taxed as regular income. To be qualified, a dividend generally must come from a U.S. company or qualifying foreign company, and you must meet a minimum holding period around the ex-dividend date. Your broker reports both types on Form 1099-DIV. Dividends earned inside an IRA or 401(k) are not taxed when paid. See Taxes on Investments for more.
Risks and trade-offs
- Dividends are not guaranteed. Companies can cut or suspend them, and often do in recessions.
- A high yield can be a warning. A yield jumps when the price falls, which can mean the market expects a cut.
- Concentration. High-dividend stocks often cluster in a few sectors, such as utilities, energy, financials and consumer staples.
- Total return matters. A dividend is one part of your return. A stock that pays a large dividend while its price steadily falls can leave you worse off.
Dividend-focused index funds and ETFs spread the risk across many companies. As with any fund, compare the expense ratio and read what the fund actually holds.
Sources
- Investor.gov: Ex-dividend date
- Investor.gov: Dividend reinvestment plans
- IRS Topic 404, Dividends
- IRS Publication 550