#FUNdfact: Dividends, coupons and gains, oh my!
We have a go at explaining what a dividend is.
When you invest into funds on Sharesies, you’re shown that there are two ways you can make money.
These are by a ‘price increase’, which is exactly what it says on the tin. You buy for $3, sell it for $5, you made $2. Pretty straightforward stuff… (it’s not really, but we’ll get into that another time). And ‘dividends’.
But what exactly are dividends?
Dividing up the dividends
When you own shares in a company, you essentially own a little piece of that company (or when you’re investing in an Exchange-traded Fund, a little piece of a bunch of companies).
When that company makes a profit, it may choose to give that profit back to its owners (IE: you) in the form of dividends.
The more shares you own, the more of these profits you’ll get.
For example, the NZ Top 50 Fund recently paid 3.5 cents per share in dividends to its shareholders. That means if you had 1,000 shares, you got 35 bucks from the combined dividends of the companies in the NZ Top 50.
Clipping coupons
A close cousin of dividends is a coupon. This is the payment on a bond. A bond is really straightforward: it’s a loan, just like your credit card or a hire purchase agreement.
When you buy a bond, you’re giving a loan to a company or organisation (like the Government).
With this, you’re buying an agreement for an organisation to pay you a fixed amount at a certain time. This fixed amount is the coupon.
Let’s say you take $100 and buy a bond from a company that agrees to pay you $101 in a year’s time. The $1 is the coupon. Math whizzes reading this will recognise it as a 1% return.
Who wins?
The good thing about bonds is that they’re super predictable. As long as the organisation doesn’t collapse in on itself, it’s almost certainly going to pay you your coupon.
The bad thing about bonds is….that they’re super predictable. If a company has a great year, your coupon is going to be the exact same same as if it had had a lean year. So you when you buy bonds, you give up some of the potential upside that dividends offer in exchange for predictability.
This is why retired people often have lots of bonds, as they need regular, stable income from their investments rather than potential growth.
Sounds great!
This is topical because globally, shares just paid a record-breaking amount of dividends. Great! This surely must mean that dividends are a one way ticket to free money town, right?
Not so much, unfort. The fact that shares are paying a lot of dividends at the moment doesn’t mean they’ll continue to do so.
Also, consider that when a company pays dividends, it’s making a conscious choice not to reinvest that money into its own growth. It’s like picking all the fruit off a tree and selling it, when you could use the seeds from some of that fruit to plant a new tree.
What to do?
So there’s no right or wrong answer when it comes to dividends or coupons. Rather, you just need to consider what you want from your investments: do you want predictable, safe, but relatively low payments? Or do you want less predictable payments that have the potential to go much higher? It comes down to your preferences and what you want to get out of investing.
Ok, now for the legal bit.
Investing involves risk, including the potential loss of principal. The info provided above isn’t a recommendation to buy, sell or hold any financial products available through the Sharesies platform. Before investing, consider your investment objectives and read the fund’s product disclosure statement carefully. It contains the fund’s investment objectives, risks, charges and other information which should be considered carefully before investing.
