Every line of work has it’s own jargon, and we are no exception. As the old saying goes, “Words mean things.”
This time of year one of our concerns is called “Buying a Dividend.” While the main concern this time of year is with mutual funds, a general description of dividends is timely:
- Dividends are a company’s way of distributing some of it’s profits to it’s shareholders (dividends apply to stock, or equity holdings)
- Many people want to own equities, which have a good chance of appreciating
- Dividends for these equity-holders are a source of investment income
- Companies pay dividends as a means of attracting new investors to their stock
- And while a stock trading at a higher price does not directly benefit a company, a high stock price is good for prestige
- It also comes in handy if a company wants to expand by issuing new stock, which will then hit the market at a higher price
- Different companies pay dividends in different manners; monthly, quarterly, semi-annually or annually
- Some companies declare “special dividends” once in a while to clear out accumulated cash balances (keeping the IRS off their backs)
- In general, the dividend announcement goes like this:
- First there is a “declaration date,” which is the date of the formal announcement that a dividend is coming
- Second is the “Record date,” which means that owners of the stock (owners of record) at the close of business that day will receive the dividend
- Then, the next day is called the “ex-dividend date.” And means the first day that the stock purchaser will be able to buy without receiving the dividend
What happens next is interesting. First, the dividend becomes taxable to the owners of record on the Record Date, who will receive the dividend payment. Next, the following day the market opens the stock at a new price, computed by subtracting the dividend amount from the closing price of the stock the day before.
For example, if a $20.00 stock declares a $1 dividend, on the ex-dividend day the stock opens at $19.00. Mutual Funds, as holders of large numbers of assets, pay not only dividends, but also may pay out short-term and long-term gains accumulated during the year (together these are called Distributions). This is generally done once per year, and most often late in the year.
Taxation of dividends from a fund comes in the form of ordinary dividends, qualified dividends, preferred dividends, short-term capital gains, and long-term capital gains. Taxation of those components is a subject for another time. For now, just know that the mutual fund distribution is taxable to the owners of record.
“Buying a Dividend” refers to the purchase of a mutual fund shortly before the Distribution is made (usually once per year in the Fall or early Winter.) This results in a taxable event, without a corresponding increase in value. Worse yet, the Distribution may be reinvested by the fund, meaning you incur taxes and have no cash to cover the tax.
Of course, none of this is important if the asset is owned inside a qualified account such as an IRA or 401(k). We avoid Buying the Dividend for our clients with taxable accounts. How? It just got easier with a website calledCapGainsValet.com.
This site monitors mutual funds and posts the expected Distribution dates for the funds. A quick look at the site will tell you if (a) the date has been announced, and (b) what the ex-dividend date will be. I always suggest that you go to the actual fund’s website to verify, but the free site CapGainsValet.com is a great service.
Then postpone the purchase until the ex-dividend date – DONE!
Listen to the Van Wie Financial Hour every Saturday morning from 10:00 to 11:00 for information regarding your investments and other personal financial topics on Newstalk AK600 and FM100.3, WBOB, or online on TuneIn Radio.