What do dividends mean for me?

July 15, 2009 7:55 AM

My stocks are paying dividends. Please teach me about this.

I am gainfully employed and buying stocks for the first time in my life. I bought them with retirement in mind. Several of the stocks have now announced dividends. What does this means for me?

I know the basics: if I am to get fifty cents per share, and if I own two shares, then I will receive one dollar. That's where my knowledge stops.

What does "receive" mean? How do I actually get the money? Will I have to pay taxes on that hypothetical one dollar? I understand you can turn dividends back into stock. How do I do this? If I only have a one dollar dividend and a share of the stock costs two dollars, does that mean this option is not available to me? It has been suggested to me that the dividend is deposited into my investment account. If this is the case, and if I immediately reinvest it on my own, do I pay taxes?

These are certainly not the the only questions I would like answers to, just the ones that come to mind!

posted by jefficator to work & money (22 comments total)

It depends on how you set things up with your investment account. Usually it's set up so that the dividend is automatically reinvested in the same stock or mutual fund whence it came. Alternatively it can be left in your account to be invested however you see fit or it can come to you as a check.
posted by jedicus at 8:07 AM on July 15

Yes, you usually receive the dividend back in your investment account. You do have to pay taxes on it too, unless there's a workaround that I don't know.

Beware that because of when these are paid you're probably going to get the 1099-DIV quite late from your brokerage next year, I got my first one in March this year and had already filed so had to refile.
posted by IanMorr at 8:12 AM on July 15

When you buy the shares, you can select whether to have the dividends paid in cash or automatically reinvested. If you selected the first option, they will be paid into your brokerage account and you won't have to do a thing. If you hold your stock certificates yourself, the company whose stock you own will send you a check in the mail.

There are no tax advantages to reinvesting the dividends either automatically or manually, but you will not pay brokerage fees for the former.
posted by gabrielsamoza at 8:13 AM on July 15

Hey good on you for starting to invest so early!

For a long part of my investment career I've targeted dividend paying stocks, and now at the age of 52 I've been able to take a couple of years off work to complete an MBA, while living off the cash flow. So dividend paying stocks are strategy that, if engaged while one is young enough (as it sounds you are) can pay significant benefits later in life.

I have previously answered a question on cash flow investing (targeting dividend paying stocks), so you might want to take a read of that. I've listed a few books & web sites as well that you may find helpful.

But in any case I'll try to deal with your questions one by one.

What does "receive" mean? How do I actually get the money?

You get paid, almost always in money. Sometimes in shares, but this infrequent.


Will I have to pay taxes on that hypothetical one dollar?

Yes, dividends are taxable income.


I understand you can turn dividends back into stock. How do I do this? If I only have a one dollar dividend and a share of the stock costs two dollars, does that mean this option is not available to me?

You should read about Dividend Reinvestment Plans, or DRIPs. If you are enrolled in a DRIP you can purchase fractional shares e.g., receive $1 dividends for $2 stock, and they will purchase a hypothetical (but dividend paying!) one half share.


It has been suggested to me that the dividend is deposited into my investment account. If this is the case, and if I immediately reinvest it on my own, do I pay taxes?

You know until about ten years ago or so if your took your dividends as shares (DRIP) you didn't pay taxes. Bastards closed that loophole.

Finally, for my own purposes I always take dividends in cash. I don't like dollar cost averaging myself, it simply doesn't work for the thinly traded, relatively illiquid securities I target. But early on in your investment career, it may make sense to have cash flow automatically reinvested into additional, cash flow generating shares.

Good on you for starting so early. I'm a firm believer that if one doesn't acquire their own capital they will always be a slave to someone else, and I try to help others realise their freedom. Sounds like you're well on your way.

Anyhow, hope this helps!
posted by Mutant at 8:15 AM on July 15 [14 favorites has favorites]

Will I have to pay taxes on that hypothetical one dollar?

Yep. Well, it's complicated. They'll mail you a form (1099-DIV, maybe a 2439) at the end of the year saying what different kinds of dividends they're paying you, and when you fill out your 1040 there's a line for the different kinds. If you have more than some number ($1500 I think), you have to fill out and attach Schedule B.

You have to read the instructions for form 1040 and schedule B. The agonizing details are in pub 550.
posted by a robot made out of meat at 8:16 AM on July 15

I am gainfully employed and buying stocks for the first time in my life. I bought them with retirement in mind.

Good idea, stocks are a good investment for retirement. For most people, buying an index fund that invests in a large group of stocks is a better choice than buying individual stocks because it is much more diversified and involves less fees, but as long as you don't put too much money into any individual company you should be fine.

Also, note that if you are buying stocks in a taxable account (such as a normal brokerage account), you'll need to pay taxes on your earnings every year. Depending on your situation it might be less of a hassle and earn you more money to invest in an IRA or 401k, which earn money tax-free, especially since you are saving for retirement anyway.

What does "receive" mean? How do I actually get the money?

Unless you signed up to have them reinvested, the money will show up in your account, just like interest in your savings account.

Will I have to pay taxes on that hypothetical one dollar?

Yes. Your broker will send you some tax forms at the end of the year detailing among other things your dividends. You'll need to then report the same information on your taxes.

I understand you can turn dividends back into stock. How do I do this? If I only have a one dollar dividend and a share of the stock costs two dollars, does that mean this option is not available to me?

Most brokerages will let you sign up to have your dividends reinvested, but doing that will depend on the brokerage. If you do sign up, you'll get fractional shares (so that you'll have 2.05 shares after your dividend pays out).

It has been suggested to me that the dividend is deposited into my investment account. If this is the case, and if I immediately reinvest it on my own, do I pay taxes?

Yes, just like if you got a bonus at work and immediately invested it. From the government's perspective, the dividend is you getting paid directly, which is different than something you already paid for increasing in value.
posted by burnmp3s at 8:16 AM on July 15

One more basic: if you get fifty cents per share as a dividend, the share price will go down by fifty cents as well.

If you are setup to reinvest your dividend, you buy fractional shares.

You pay taxes whether you reinvest or not. Dividends can be "qualified" or not, depending on whether you've held the stock for longer than 60 days (roughly). Qualified dividends qualify for a lower tax rate, 5% or 15%, the same as long-term capital gains. Non-qualified dividends are taxed like normal income, so 25% and up.
posted by smackfu at 8:17 AM on July 15

If you are in the USA and the investments are not held within an IRA, then, yes, the dividends are taxable. Currently, you'll pay 15% (unless you are in the 10% or 15% tax brackets, in which case you pay zero).

Normally, the money will go into your investment account. If the stocks you hold give the option of a DRIP (Dividend Reinvestment Plan), then you can arrange to have the dividend paid out as stock (you are still responsible for the tax through). Check the corporation's website to determine if this (or try a search).
posted by ssg at 8:22 AM on July 15

I don't recall having been given the option to reinvest when I bought on scottrade. Does this brokerage offer that option?
posted by jefficator at 8:38 AM on July 15

jefficator -- "I don't recall having been given the option to reinvest when I bought on scottrade. Does this brokerage offer that option?"

They more than likely do; I'm with Fidelity myself, and I have to call to ask them to enable or disable automatic reinvestment. Its worth a call in any case.
posted by Mutant at 8:47 AM on July 15

The answers above have addressed your issue directly, but I also wanted to suggest that you take the time to learn a little more about all the different investment avenues that are open to you. There are countless online and offline resources out there, but as a starting point, you should check out this free course on Morningstar that I saw recently (it's in a pretty easy-to-digest format). It will help you cover the basics and give you a better idea of the topics that you might want/need to investigate further.
posted by vall at 8:54 AM on July 15

Does this brokerage offer that option?

No, I have a Scottrade account and they do not (as far as I know). So the dividend will get paid into your account as cash, and earn 0.05% interest. (Yes, that is 1/20 of 1%.) If you have enough equity, you may wish to sign up for check-writing on your account which would make it easier to withdraw the cash. Otherwise you need to request a check by phone.
posted by smackfu at 9:15 AM on July 15

I am gainfully employed and buying stocks for the first time in my life. I bought them with retirement in mind.

You should max out your 401(k) and IRA before buying stocks in a taxable account. This will allow you to avoid the issue of taxes and provide a higher return. Most people would be much better off buying mutual funds than trying to pick individual stocks.
posted by JackFlash at 9:20 AM on July 15

One more basic: if you get fifty cents per share as a dividend, the share price will go down by fifty cents as well.

What?
posted by dzot at 9:54 AM on July 15

dzot: One more basic: if you get fifty cents per share as a dividend, the share price will go down by fifty cents as well.

What?

The value of the stock goes down by the amount of the dividend and therefore the price adjusts accordingly. The drop in price may be hidden by the normal daily noise in the market but it is there nonetheless. If this were not true, you could make free money by just buying a stock a day before the dividend and selling the day after. Arbitrageurs do not allow this to occur and the price adjusts as described. It just isn't obvious because a quarterly dividend is usually less than 1%.
posted by JackFlash at 10:10 AM on July 15

The value of the stock goes down by the amount of the dividend and therefore the price adjusts accordingly. The drop in price may be hidden by the normal daily noise in the market but it is there nonetheless. If this were not true, you could make free money by just buying a stock a day before the dividend and selling the day after.

Except I would outsmart you by buying two days before the dividend and keep the money myself. Then you would outsmart me by buying three days before...

The effect of going ex-dividend is trivial because dividends are valued by the market based on the expected future dividend stream, not a one time payment.

Whatever the case, if you get fifty cents per share as a dividend, the share price will go down by fifty cents as well, is enormously misleading.
posted by dzot at 10:33 AM on July 15

So the dividend will get paid into your account as cash, and earn 0.05% interest. (Yes, that is 1/20 of 1%.)

I'm not sure if it applies to Scottrade, but at a lot of brokerages you can request to have your cash automatically invested into a money market fund, which would give you a better interest rate.
posted by burnmp3s at 10:40 AM on July 15

dzot: Whatever the case, if you get fifty cents per share as a dividend, the share price will go down by fifty cents as well, is enormously misleading.

Actually it is true. Markets could not rationally function otherwise. You just are not aware of it because dividends are usually only pennies a share. For a better example look at this chart for Microsoft prices on the day before and the day after their record $3 per share dividend on Nov. 15, 2004. The price drops by $2.63 from market close on the day of the dividend to market open the next business day. The .37 difference is just market noise.

Prices have to work this way. On day 1 the value of the stock is the price including the dividend. On day 2 the value of the stock is the price without the dividend. Ignoring other market changes, the two have to equal each other in a rational market.
posted by JackFlash at 11:13 AM on July 15

On day 2 the value of the stock is the price without the dividend. Ignoring other market changes, the two have to equal each other in a rational market.

I disagree since this implies dividend-paying will take a stock to $0 over time but clearly this isn't the case.

The term of art is "distribution of capital". The MSFT case above was the latter. Dividends from earnings are expected and are priced in since purchasers are looking primarily at the dividend yield % in comparison to other investment alternatives in the universe.
posted by @troy at 11:40 AM on July 15

JackFlash is correct. I'm wrong (in any practical sense, anyway). That's what I get for being a buy-and-hold guy.
posted by dzot at 11:48 AM on July 15

I disagree since this implies dividend-paying will take a stock to $0 over time but clearly this isn't the case.

I disagree, since this conclusion implies the remainder of the value of the stock after paying dividends is unable to appreciate in value, but clearly this isn't the case.
posted by explosion at 11:57 AM on July 15

troy :I disagree since this implies dividend-paying will take a stock to $0 over time but clearly this isn't the case.


It implies nothing of the sort. Think of a stock as an interest bearing savings account. Once a quarter you withdraw your accumulated interest from the account. The value of your account declines by exactly the amount of your withdrawal. But the principal continues to generate interest gradually over the next quarter increasing the account value, so next quarter you can do another withdrawal (dividend). The long term value of your account is unchanged although it changes substantially on the day of withdrawal.

Likewise, a company pays a dividend each quarter and on the day the dividend is paid out, the value of the company drops by the amount of the dividend. But the company continues to generate saved earnings so its value gradually goes back up again until the next dividend. Part of the value of a company is the cash it has in the bank. On the day it pays a dividend and reduces its cash, its value declines. As the company accumulates more cash again, the previous value returns. If the company expands and grows, its long term value may even increase over time, but that is a separate issue.
posted by JackFlash at 12:21 PM on July 15