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In our Investing series, there is something we did not yet cover in detail: Dividends. Many companies in the stock market are paying dividends to their stockholders. That means if you own a share of Coca-Cola, you will receive some cash four times a year, every quarter.
Receiving dividends is an excellent way of accumulating cash since it does not require you to do anything. It is an entirely passive income. It is probably the only truly passive income there is. You still need to buy the shares, of course. But once it is done, you will get the money.
There are many important things to know about these dividends, and we cover them all in this article. If, like me, you are investing the entire market, you will get some dividends automatically!
As mentioned before, some companies pay a dividend to each share holder.
The company is setting how much money they give away per share per year. For instance, one company could give 20 cents per share as a dividend each year. Most companies pay dividends once per quarter. For the previous example, that means you would be receiving 5 cents every quarter.
There is no official schedule for dividends. Each company can do what they want. Most companies pay it every quarter. But some companies are paying it once a year and some others once a month. If you want this information, you must look online or ask the company.
Some companies can start to pay dividends at any moment. They can also stop paying dividends at any moment. The company decides to pay or not a dividend based on what they believe is the best for the company’s future.
For instance, famous Warren Buffett’s Berkshire Hataway paid a dividend only once in all their years! On the other hand, some companies have paid dividends for more than 50 years without interruption. In a strong bear market or a general recession, you may find that many companies will cut their dividends.
Generally, the company will publish the dividend paid per share (DPS). However, this number alone is not useful because it depends on the share’s price.
A metric that is useful is the Dividend Yield. This yield can be easily calculated by dividing the dividend per share by the price (DPS / Price). For instance, if a stock is trading at 50, and they paid a dividend of 2 dollars per share, the yield is 4% (2 / 50 = 0.04 = 4%). This yield is the yearly return (in dividends) you get by buying a share of this company.
Important Dividends Dates
There are several important dates for each dividend from a company:
- Declaration date: When the company announces its intention to pay a dividend. It is not a very important date for investors. However, if you are a dividend investor, this could be important. You need to keep track of the dividend increase of companies.
- Record date: It is the date the company checks the records to gather the list of shareholders. It is the last day you can buy shares and still get dividends. If you sell before this date, you will not get a dividend.
- Ex-Dividend Date: This is probably the most important date. Only holders that purchased shares before the ex-dividend date will receive the dividends. After this date, you can sell your stock, and you will still receive the dividend on the payment date.
- Payment Date: This is the date at which you will receive your money.
But unless you focus on dividends, you do not really have to learn all these dates.
If you are interested in dividends, you will likely hear the term dividend aristocrat.
This term was used first to define the stocks from the S&P 500 index that increased the dividend they pay per share every year for at least 25 years. Now, it is also used for companies outside of the S&P 500 index.
These companies are generally safer bets than others. They steadily increase their dividend each year. Of course, it does not mean that they are without risk. Many companies were removed from the list during the 2008-2009 crisis because they decreased their dividends. And even a company with an excellent history of dividends can stop paying them.
Some people are only investing in companies that pay a dividend. This investing strategy is called dividend investing. This investing strategy is a form of value investing where some of the value estimations is based on the dividends paid by the company. Although he does not only invest in dividend-paying stocks, Warren Buffet greatly likes dividends.
He also invested several times in preferred stocks. The stocks sometimes get a higher dividend and the dividends before the other stocks.
The easiest way to invest in dividend-paying stocks is to choose a dividend stocks ETF. There are many of them already. For instance, I used a Swiss dividend-paying fund for my home bias in my portfolio.
However, most dividend investors are investing themselves. That means they have to choose stocks themselves. Most dividend investors have between 20 and 50 stocks in their portfolios. You may think it is as easy as taking the stocks with the highest dividend yield. But that is not the case.
Some stocks have high dividend yields for bad reasons. For instance, they may want to attract investors in bad financial shape. And some companies are paying more dividends than they earn money. And some stocks are selling higher than their valuation. All these reasons make dividend investing something that is not trivial.
You need to collect a lot of information on the dividend-paying company before you buy its stock. For instance, one of the things you want to consider is the Dividend Payout Ratio. It represents how much of the earnings are spent on dividends. But there are many factors to consider.
I am not a pro of dividend investing. Also, I am not doing any dividend investing. There are many personal finance bloggers out there that invest in dividend stocks. If you want more details, you should look at their blogs. Here are a few I am following:
But there are many more out there. It is an investing trend currently. Search dividend blog on Google, and you will find more than you can read.
Problems with dividend investing
As with everything, not everything is perfect about dividend investing.
Usually, when a company pays dividends, its stock price decreases by the same amount as the dividend paid. If you have a stock worth 100$ that just paid you 3$, the stock will go down to 97$. You still own 100$ as before.
You have the advantage of having some cash that you can reinvest. But your total investment remains the same. If the company could grow faster by reinvesting the dividend in itself, you are losing on potential capital gains.
The earnings that are not distributed as dividends are reinvested into the company. It is a form of automatic compounding. What is interesting here is that most companies in the stock market trade at higher than their book value. That means that their shares are more valuable than their assets.
For instance, the stock is traded at three times the book value. It means that one dollar reinvested in the company has more potential than one dollar of the distributed dividend. It is one of the reasons that Warren Buffet’s Berkshire Hataway has not paid any dividend in the last fifty years.
Currently, there are a lot of dividend investors. It is a real trend. The issue with that is that it puts a lot of pressure on the price of the dividend stocks. The price per earnings (P/E) of the most popular dividend stocks has skyrocketed.
These stocks are now more expensive than the average in the stock market. And the only reason for that is that they pay dividends. Several early dividend investors have mostly stopped investing and are now holding cash for the next opportunities. Some of them started investing in other things, such as Real Estate instead.
That is not to say that dividend investing is a bad thing. But before you invest in dividend stocks, you need to be aware of the method’s limitations.
For more information, you should read about the biggest issues with dividend investing.
Dividends and Financial Independence
When planning to be financially independent through your portfolio, dividends will be great.
You will receive directly some cash every few months. You can use this cash to cover your expenses instead of selling shares. This extra cash is an excellent thing since selling shares is not free while receiving dividends is free (of fees, not taxes).
There is a specific advantage to dividends in retirement in Switzerland. If your capital gains make up more than half of your income, you will be considered a professional investor. Once it becomes the case, your capital gains will become taxed. This law means you should get half of your income to be dividends to avoid many taxes!
Dividends in Switzerland
Dividend investing is not very popular in Switzerland. And there is a good reason for that. Dividends are not tax-efficient in Switzerland.
Indeed, dividends are taxed as income, while long-term capital gains are not taxed. That means that it is more efficient to rely on capital gains. This tax inefficiency is contrary to many other countries. Indeed, in most countries, capital gains are more taxed than dividends.
When you receive a dividend in Switzerland, your broker will withhold 35% for the tax office. If you declare them as income in your tax declaration, they will refund it. But this will increase your income. And increasing your income will increase your taxes. Therefore, your dividends will be taxed at your current marginal tax rate. It is why many people in Switzerland do not like to invest in dividend stocks.
But as mentioned in the previous section, they are quite crucial for financial independence!
How to avoid dividends
For tax reasons, some people may want to avoid dividends altogether. Avoiding them is not as straightforward as it seems.
The first idea should be to use accumulating funds instead of distributing them. These funds reinvest the dividends instead of distributing them to shareholders. But in Switzerland, this is still counted as dividends. So accumulating funds are as tax-inefficient as distributing funds. Therefore, the only way to reduce taxes is to actually reduce the total amount of dividends you receive.
With broad index funds, you will always receive dividends. If you are willing to avoid them, you must rely on single stocks. Some companies, like Google, do not distribute dividends. So, you could create a portfolio of these companies. But there are not that many of them. So, you will not be very diversified. And it will be very difficult to replicate the performance of this pseudo-index.
One better way would be to invest in Berkshire Hataway, which represents the investments of Warren Buffett. And Berkshire Hataway does not pay dividends. So, you will have a pseudo-fund without dividends. But I still think this is inferior to investing in the broad market.
Avoiding dividends while passively investing is almost impossible. The thing you should do is avoid indexes that focus on dividend-paying companies.
Dividends are regular payments that companies make to shareholders. The companies distribute some of their earnings directly to the shareholders instead of reinvesting them. Dividend investing is a very popular investing strategy. Unfortunately, this popularity made dividend-paying stocks more expensive than regular stocks.
I like receiving a dividend. It is some extra money as passive income. It feels good to receive this money. However, I am not investing mostly in dividend companies. For now, I am primarily investing in the entire market for good diversification. Even with this, I have a dividend yield of about 1.7%. It is not high yield. But it is still a good passive income.
In Switzerland, it makes more sense to invest in capital gains rather than dividends. Indeed, capital gains are tax-free, while dividends are taxed as income. Therefore, I would not recommend focusing on them in Switzerland.
What do you think about dividend investing?
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