Total investment returns include both capital gains and dividend payments. Capital gains are the sum difference between the buying and selling prices of investment units. Meanwhile, savers may also collect cash dividend payments as passive income that may be either spent, or used to purchase additional investments. Dividends generally reduce financial risks. Capital is now being returned back to investors, rather than being reinvested into the corporation and being exposed to excessive risk taking and financial losses. Savers earn dividends through stock, mutual fund, and even insurance holdings.
Calculating Dividend Yield
Dividend yield is taken as a percentage, and divides a stock’s anticipated annual dividend by its current share price. Be advised that dividends are usually paid and quoted quarterly. As such, the announced quarterly dividend amount is to be multiplied times four before calculating dividend yield. For example, Stock Z trades for $100 per share and pays a $1 quarterly, or $4 annual, dividend. Stock Z would then feature a 4-percent dividend yield ($4 / $100). An investor could therefore expect to collect $400 in annual dividend payments, after buying into $10,000 worth of Stock Z.
Stock Market Investments
Corporations finance themselves by either issuing debt, or selling shares to investors. Stock equity identifies ownership claims above the underlying business. Again, dividends, alongside stock buy backs, are a return of capital back to shareholders. Dividends are typically paid out quarterly, and investors must buy and hold stock prior to and through the ex-dividend date to receive payments.
Generally, mature companies pay higher dividend rates. Mature enterprises lack the growth opportunities of younger firms, and shareholders generally prefer that these profits be paid out as dividends. Conversely, growing companies that operate within rapidly developing industries are better served by reinvesting earnings into the business to finance expansion. Technology stocks typically make minimal dividend payments, if any.
Stocks that pay dividends are categorized into common and preferred shares. Preferred shares lack voting authority, but are prioritized to receive dividends before common stock. Common stock investments pay smaller dividends, but carry voting power, and the potential for higher returns relative to preferred shares.
Although dividend income is important, do not base stock investment decisions strictly upon these payouts. Corporate earnings are the primary driver behind stock market performance. A struggling business will eliminate dividend payments altogether, prior to declaring bankruptcy.
Mutual Fund Investments
Smaller investors may put money to work within mutual funds to automatically access both professional management and diversification. Mutual funds are especially popular as part of 401(k) plans. Sector specific mutual funds may target distinct asset classes, industries, and global regions, for building out portfolios. Mutual fund shareholders are paid dividends in proportion to their ownership percentage of the capital pool.
Mutual fund investments lack the control afforded to common stock shareholders. Mutual fund investors may vote over issues related to the fund, but cannot voice their opinions over matters affecting the underlying investments. Further, mutual fund investors lose the authority to select individual stocks according to preferable dividend rates and schedules. Timing is a concern for budgeting and tax purposes. Individual stocks can be bought to design portfolios that pay out dividends at regular intervals and defer taxes. Conversely, mutual fund managers are authorized to buy and sell securities at their own discretion. Frequent trading activity within the fund may expose savers to large capital gains taxes.
Life Insurance Dividends
Life insurance is grouped into term and whole life policies. Term coverage extends over the insured for a particular time frame. Permanent, or whole life insurance, remains in force for as long as the insured continues to remit policy premium payments. Whole life insurance also features a savings component referred to as cash value. Whole life insurance premiums go towards paying the cost of insurance alongside buying money market securities and mutual funds that build cash value. The cash value grows as it earns dividends, and may be withdrawn at any time.