When you own stock in a company or many companies such as through a fund, you are more than just an investor, you become a small owner in those businesses. So if the business does well you can expect the share price to rise which increases the value of your investment.
Since businesses appreciate you supporting them they also offer a reward for your loyalty. That reward is called a dividend which is a sum of money paid regularly by a company to its shareholders out of its profits. Dividends can be paid monthly, quarterly, every six months or yearly.
Who Pays Dividends?
Not all companies pay a dividend. Typically small companies or new companies just starting up don’t have any profits yet to start paying a dividend. Alternately older well established companies such as Coca Cola or Ford have a long uninterrupted history of paying dividends.
How Are Dividends Paid?
A dividend is paid as a percentage of your investment and is often referred to as the yield. Typically dividends have a yield between one and five percent with the average being near two percent.
Dividends are typically paid as a cash amount per share owned. So if the dividend is nine cents and you own 500 shares the payment would be ($0.09 X 500) which is $45. That money would be added to your investment account as cash. It’s a nice bonus but you can do much better by using the magic of compound growth.
Reinvest Those Dividends
Suppose that dividend was paid as part of a fund you own. You can specify to the fund management that you want your dividend automatically reinvested (DRIP) to buy more shares of the fund. So if the fund shares are trading at $20, the managers would automatically buy two more shares from your dividend and the leftover $5 would be left as cash in your account.
Unfortunately you can’t buy fractions of a share. The beauty of this is you pay no transaction fee when buying shares from reinvested dividends. Eventually when the leftover cash in your account grows enough you can buy an additional share but you must pay a transaction fee.
Every time you are paid a dividend you receive money based on the amount of shares you own. And since you’re using that money to buy more shares, the next dividend payment will be higher since you now own more shares. This is the compound growth in action.
So if you purchased shares of a fund in January and at the end of the year the share price is exactly the same as when you bought you might believe you’ve broken even. But, let’s say the fund paid quarterly dividends meaning you’d own mores shares so your investment has actually grown. While the price of the fund shares you own will change the dividend growth is constant. A dividend is a guarantee of growth and the growth is exponential.
What Are the Advantages of Collecting Dividends?
Once you specify that you want your dividend automatically reinvested you’ll never see the cash and the temptation to spend it will be gone. The amount of shares your dividend can buy depends on the share price. In down times or a recession when the share price drops your dividend will buy more shares.
Recessions actually help your investment grow. If your investment is sheltered in an RRSP or TFSA you won’t pay any taxes on the dividend gains. Dividends are an excellent way to grow an investment and help minimize the long term effects on inflation on your spending dollar.
Getting a better return on your money requires taking on risk which means investing in the stock market. Dividends are a nice margin of safety to ensure constant compound growth over time.
In my E-books (“Water Barrel” and “The Balance”) I discuss simple methods to live sensibly for today, take charge of your financial affairs, and invest safely for the long term. For more information please visit David Penna Amazon.
As always, I am not a qualified financial advisor. I just relate financial management to my own experience which may not resemble yours at all. Advice is frequently worth exactly what you paid for it. Most of mine came from expensive experiences.