What To Do With Dividends
What are dividends? How do you get them? And more importantly, what do you do with them?
Dividends are often an overlooked area of investing but can play a critical role in building up your portfolio.
In fact, taking advantage of dividends and, more importantly, dividend reinvesting, could be one of the smartest investing moves you can make!
What are dividends?
Loosely speaking, dividends are pay-outs of a company’s earnings to company shareholders, as decided by the board of directors. They’re usually cash payments but can sometime be pay-outs of shares of stock or other assets.
So when a company records a profit, they can either pay this additional money out to shareholders (i.e. dividends) or keep it within the company as retained earnings.
Why pay dividends?
There are several reasons for a company to pay dividends rather than to reinvest profits back into the business. One of the main reasons is to tempt investors to buy more stock: if a company regularly gives out dividends, it can attract an investor looking for extra income, and thus to invest in the company and take advantage of the regular cash pay-outs.
Dividends can also act as an indication of a company’s strength: paying out a dividend can indicate that company management has positive expectations for future earnings. Positive outlook means more attractive to investors.
How do I get them?
First, you need to own stock in that company. Let’s take Apple as an example. Earlier in 2017, on February 16 to be exact, Apple paid out a dividend to shareholders. For every 1 share, Apple paid out 57 cents. Doesn’t seem like much, right?
Well, that’s just for 1 share. You get $.57 for each share you own AND pay-outs typically happen every quarter. So for every share you own, you get a dividend pay-out every 3 months — money you are earning just from owning the stock. Ears pricked yet?
Apple’s dividend pay-out relative to share price (known as the Dividend Yield) really isn’t that high: it sits at around 1.6%. Many companies are much higher: IBM and Coca-Cola have yields well above 3% and GM’s yield is close to 5%. There are many others, too.
If you’re looking specifically for dividend-giving companies, note that start-ups and other high-growth companies (like in technology or bio-science sectors) are unlikely to give out dividends, since most of their profit will be reinvested in the company, to sustain rapid growth and expansion.
Should I cash out, or reinvest?
Once you have your dividends, what should you do with them?
A dividend reinvestment plan (a.k.a. DRIP) is an easy way to automatically use your dividends to buy more shares of the stocks in your portfolio and is a common solution for many.
By reinvesting, the money will not only potentially grow in value, but may also earn you more in dividends, resulting in a snowball effect for the duration of your investing period (thanks to the power of compound interest!). It therefore makes sense to reinvest rather than cash-out, since the future potential is huge.
Enrolling your stocks in a dividend reinvestment plan is one of the best ways to grow your portfolio over the long run. If you have a comfortable level of income whereby you don’t need the cash immediately, dividend reinvesting is a convenient way of growing savings, ultimately leading you to investing success.
Take advantage of the compounding effect and set yourself up for investing success today with dividends.
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