When you buy shares in a company, you’re effectively buying a piece of that company which means you’re a part-owner. As a shareholder you’re entitled to a share of the company’s earnings, which comes in the form of dividends.
Learn about the different types of dividends, how they’re applied and how they impact your taxable income in this guide. Plus, compare a range of online share trading platforms which allow you to start buying shares in companies that pay dividends.
A dividend is a share of a company’s earnings given to shareholders as a cash payment into their bank account, usually twice a year. The size of the dividend you receive is in proportion to the number of shares you own. The more shares you own the bigger your dividend payment will be.
For example, let’s pretend a company that sells items for household pets called Pets Galore is offering a dividend payment of $0.05 for each share held. If you owned 1,000 shares, you’d receive a dividend of $50. However if you owned 10,000 shares, your dividend payment would be much larger at $500.
In order to receive a company’s dividend payment, you must hold the shares prior to its ex-dividend date. If you buy shares on or after an ex-dividend date, you will be eligible for the next dividend payment, if there is one.
Instead of paying shareholders a dividend, a lot of smaller, newer companies will reinvest any profits made back into the company to help it grow. However, many investors are okay with this because if the company is growing, the value of their shares will grow too.
It’s also important to note that dividends are never guaranteed. Each company decides what the value of the dividend will be and if there will even be a dividend payment at all, annually. So just because a company pays a large dividend one year, it doesn’t mean it will do this again the following year.
The dividend yield is presented as a percentage and is an indication of the value of the dividend payment in relation to the cost of the shares. The dividend yield is calculated by determining what percentage of the share price is returned to the investor as income. The dividend yield helps investors compare similar companies, as it gives you an idea of which one offers a better return on your money in the form of a dividend.
Let’s look at company Pets Galore again with its dividend payment of $0.05 per share. If the current share price was $2 per share, the dividend yield would be 2.5%. If the share price was instead $0.50 per share, the dividend yield would be a lot better at 10%. Because the yield is calculated using the share price, the yield will change daily as the share price changes.
There are 3 main types of dividends, but not all companies will pay all 3 types to shareholders (and some won’t pay any at all!).
Because dividend payments are a form of income, you do need to include these in your total taxable income when you file your tax return. However, there are some important guidelines to keep in mind when figuring out what investment income to declare and how much tax you’ll have to pay:
Some companies offer what is called a dividend reinvestment plan (known as a DRIP), which allows you to opt in to using your dividends to buy more shares in the company, instead of receiving the dividend payment in your bank account.
There are several advantages of doing this, but the main one is you’re able to use the money to buy more shares without paying any brokerage fees. It’s also a good, passive way to increase your position in a company gradually over time with little to no effort from you. It’s a good set-and-forget investment strategy: once you opt in, it all happens in the background automatically.
One downside of opting in to a DRV is you’re unable to use that cash for day-to-day purchases like you could if you had received it into your bank account. You also don’t get to choose at what share price you’d like to buy more shares: the shares are automatically bought on your behalf on the date of the dividend payment.
If you’re comparing a bunch of dividend-paying companies, here are a few things to keep in mind.
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