Dividends 101: How Do They Work?

Dividends in nutshell : The idea behind a good investment is not to work for money and make it work for you instead. And as far as investments go, dividend-paying stocks have turned out to be the easiest and best way to build on your wealth over the long haul. Despite the great appeal of owning companies that continue to grow bigger and more profitable, dividend stocks are often an underrated means of investment.

In fact, if you are not already deep-set into investing, you’re probably asking, “what is a dividend, and how does it work?”. Much to your luck, you have stumbled upon just the right page to learn about it.

The simplest answer to “what is a dividend?” is that it is a regular payment of a profit that a business generates to shareholders. They are generally perceived as rewards to shareholders for putting their capital into the business. Owning these stocks not only helps you build greater long-term wealth but also saves you the hassle of keeping a keen eye on short-term stock market movements.

So now that you know the basics, let’s take a deeper dive into what these financial instruments are and how do dividends work!

What is a Dividend?

A dividend is a share in a business’s profits paid to the shareholders quarterly, like a bonus reward for investing. It is a way to allow shareholders to participate and claim a share in the growth of the business above the original share price. The dividend per share is often worth a few pennies, which might make it sound insignificant. But they can add up into long-term wealth for the investor.

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For instance, you own 1,000 shares in a business that you bought at $10 per share. Now let’s assume that the business pays 1% dividends on shares quarterly. This means that you will receive 10-cents on every share, which will together make you earn $100 in dividends on your 1,000 shares. And that certainly doesn’t sound like a bad idea for simply owning stock in a business.

Types of Dividends

They are generally paid on the common stock of a company. Businesses have the option to pay dividends in various forms. The common types of dividends that most businesses pay are as under:

Cash Dividends

Cash dividends are the most common type of dividends. As the name suggests, cash dividends are paid in cash directly into the brokerage account of the shareholder.

Stock Dividends

Sometimes, companies decide to pay dividends in the form of additional shares of stock. These are known as stock dividends.

Dividend Reinvestment Programs (DRIPs)

If a business offers DRIPs to its investors, it can reinvest any dividends received back into the company’s stock, usually at a discount.

Special Dividends

Special dividends are paid on all shares of the common stock, but they are not paid regularly. Instead, they are issued to distribute profits that have accumulated over many years, and the company does not have an immediate need to use them.

Preferred Dividends

Preferred dividends are the dividends that are paid on preferred stock. Preferred stock works more like a bond. While dividends are paid according to the company’s quarterly performance, the dividends on preferred stock are typically fixed.

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How Do Dividends Work?

When a business generates profit, it can either distribute it among the shareholders, reinvest it into business for growth and debt reduction, or do both. The part of the profit paid to shareholders is known as dividends and the ultimate objective to buy dividend stocks for most investors is to live off them.

Usually, the board of directors of a business decides how the company will pay its dividends to the shareholders, and when they will be paid. The most common periods for the payments of dividends are monthly, quarterly, or annually. But that’s not it; the board of directors also have to get shareholder’s vote to get the approval on the distribution of dividends that they have decided.

How are they Paid?

More often than not, they are declared and paid on a per-share basis and usually at the end of each quarter. For instance, if Coca-Cola pays $0.88 dividend per share, the investor will receive $0.22 per share four times (or quarters) a year. Some companies also pay it annually.  The board of directors announces the next payment weeks before they are actually paid.

The important dividend dates to remember are as under:

Declaration Date

Declaration Date is the day on which the company makes an official announcement that its board of directors has decided to make dividend payments.

Payment Date

On this date, the dividend payment is made to shareholders. The payment date is exactly the day when dividend checks are mailed or when the payment is expected to show up in the brokerage account. Here is a detailed article on when the stock dividends are paid out.

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Record Date

This is the date when the shareholder should be an official owner of the stock to receive the payment.

Ex-Dividend Date

The ex-dividend date is one business day before the record date. This means that to be eligible to receive a dividend on shares, you must have owned it the business day before the ex-dividend date.

Conclusion

These stocks are a staple of any investor’s portfolio and, regardless of the investor’s age, they have an important role to play. But most newbie investors dismiss them as an investment for retirement plans when, in truth, it is much like a snowball effect.

When your stocks pay, they are reinvested. The more you reinvest, the more shares you own, and the more shares you have, the greater will be your future options.

If you need a smart solution to manage your finances and keep track of your investments, download the Doctor Money app today. And remember, wise investments are your key to financial freedom. It’s never too late to start.

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