Maybe this year is the year you’re planning on finally learning about managing your finances better. In addition to saving, perhaps you’re interested in learning about ways to make your money work for you. In your learning and reading, you’ve probably come across the term “dividend,” and you might not be sure exactly what that term means. Here’s a necessary explanation of the term as well as how it should be an indispensable element of your finances.
When companies determine a need for it, they can choose to become a publicly held company by selling stock in the company. Essentially, a stock is a share in owning the company that the company sells to raise money for its business ventures. When you buy a stock, you are becoming a part owner in that company. Depending on the size and valuation of the company (how much it’s worth), there may be millions of stocks available for purchase on the stock market. Still, whether you own one stock or one thousand stocks, you’re purchasing a share of the company. When you should invest in a company is beyond the scope of this article, but suffice it to say there are a plethora of investment philosophies out there.
When a company is large enough and well-established in its industry, it will often choose to return money to the shareholders in the form of a dividend. This is money the company pays per share of stock, and it usually is paid quarterly (every three months). Some companies may pay dividends monthly or annually, but quarterly is the most common time-frame. Typically, dividend amounts are listed as the total annual payout. For instance, Company X may have a yearly dividend of $2.00 that it pays quarterly at the price of $0.50. This means simply that for every share of Company X stock that you own, you receive a payment of $0.50 per quarter. This may not seem like a lot, and your return is determined by how much you paid for the stock, to begin with. Still, the amount you receive in dividends is money that is earned by your money that you would have otherwise spent or saved in a low-yield savings account.
Dividends can be especially powerful when you’re a long-term investor that, instead of taking your dividends, re-invests them in the company. Most stockbrokers you buy stock through can enroll you in what’s called a dividend reinvestment plan, or DRIP, for each company you hold. Instead of receiving a check or direct deposit for the amount of the dividend, your dividends are automatically used to purchase more shares of the same company. This means that you are less able to control how much you purchase a stock since it’s an automatic transaction that follows the price of a share on the market at that current time. However, if you embrace a long-term investment strategy, this compounding effect can really add up over time.
In case you were wondering, dividends are taxed as income by the IRS, and you have to claim them on your taxes. The rate you pay has to do with whether or not the dividends are considered qualified on non-qualified; basically, qualified dividends are taxed at a lower rate since they have been held for longer. However, you can expect to pay anywhere from 20% to 22%, and your stock broker will send you a 1099-DIV at tax time that will help you break it down. Still, the tax is less than the dividend is, so you are still making a good investment.
There are a number of other considerations regarding dividends, the most important of which is the ex-dividend date. This is the date you had to have owned the stock before, in order to collect the payout. If a company has an ex-dividend date of September 17th, for instance, you will have had to have purchased the stock on the 16th (or whatever the previous business day was). Other dates to take note of are the announcement date and the payout date, both of which are self-explanatory. Announcement dates, especially if they involved a dividend amount that hasn’t changed or that has increased per share, will usually correspond to a small rise in a company’s share price.
Dividends are a powerful tool that every personal investor should be aware of to help grow real wealth over time. Several companies that have been multi-billion dollar corporations for years pay relatively large dividends and have had a steady increase in their dividend amount over decades. Now that you have a basic understanding of what a dividend is, it’s up to you to find where the best ones are and take the steps necessary to make sure that your money is going to work for you.