If you’ve ever received cash simply for investing in a company, you’ve likely been involved in dividend stocks. Companies pay dividends to share profits with investors, often on their common stock. Dividends are allocated per share, so if you own 20 shares of a stock that pays $5 in annual cash dividends, you’ll receive $100 every year.
Dividend investing is one way to potentially earn a return on your investments, although not all dividends are cash. If you’re interested in this investment strategy, it’s important to know how dividend stocks work.
What are dividends?
Dividends are distributions of a company’s earnings to its shareholders, typically paid out quarterly and on a per-share basis. Because holding stock in a company makes you a partial owner, you can think of dividends as your share of company profits. A company can choose to pay out these shares in several ways:
- Cash dividends: Cash is the most common type of dividend and is paid out to the investor’s individual brokerage account.
- Stock dividends: Companies with stock dividends distribute additional shares to compensate stockholders, rather than paying them a share of earnings. This typically occurs when a company wants to increase the number of shares outstanding or reward investors while maintaining liquidity.
- Special dividends: These dividends are owed to investors who hold common stock, but they’re not paid on a regular basis. Instead, a company may issue special dividends when it has excess cash that it doesn’t immediately need.
- Preferred dividends: Like its name, preferred dividends are issued to preferred stock owners. The amount is usually fixed, unlike common stock dividends, and are paid on a quarterly basis.
Dividends are the only way investors can profit from stock ownership without selling shares and eliminating all (or a portion of) their stake in the company.
What are the benefits of dividend stocks?
Dividend stocks often provide a steadier source of income than growth stocks, allowing investors to build wealth without selling their shares. But the true wealth-building power of dividend stocks comes with reinvesting your earnings. Research by Morningstar and Hartford Funds found that reinvested dividends have generated 84% of the total return of the S&P 500 Index since 1960.
Funneling your dividends back into your portfolio through automatic investing allows you to benefit from compound interest, so you continue to profit from dividends long after they are initially paid. Coupling this with a dollar-cost averaging strategy could potentially lead to millions in additional investment returns over 30 to 40 years.
Why do companies pay dividends?
When a company earns a profit and has excess cash, it has three options:
- Reinvest in its operations
- Pay down debt obligations
- Distribute the cash to shareholders as dividends
Not all corporations distribute dividends to investors. Many new or rapidly expanding companies opt to reinvest earnings in further organizational growth. But for mature, stable corporations with consistent cash flows, dividends can be a great way to reward and retain shareholders.
Investors often view dividend payments as an indication of company strength and a positive outlook for future earnings. That’s why dividend stocks are often attractive to investors looking to generate income on their holdings. Issuing dividends can increase demand for a stock and bolster the stock price.
What are dividend dates?
Investors holding dividend stocks should be mindful of four important dates:
- Declaration date: The date a company’s Board of Directors announces an upcoming dividend payment.
- Ex-dividend date: The first day on which shares bought and sold no longer carry the right to the previously announced and yet-to-be-paid dividend. If you own a stock before the market open of the ex-dividend date, you’re entitled to the dividend. If you purchase a dividend stock on or after this day, you won’t receive a dividend.
- Record date: The day after the ex-dividend date, and the date the company uses to determine its shareholders or “holders of record.”
- Payment date: The day a dividend will be paid to a stock or fund owner.
It’s important to remember your earned dividends and received dividends will differ between the ex-dividend date and the payment date. Once all earned dividends have been paid, however, these numbers will be equal.
Here’s an example of how stock dividend dates work:
Stock ABC has an ex-dividend date of January 15 and a payment date of January 25. Michelle bought a share of ABC on January 14, and Eddie bought a share of ABC on January 15. Michelle is owed the dividend, but Eddie is not. Between January 15 to 25, Michelle will have earned the dividend, but not yet received it, so her earned dividends will exceed her paid dividends. On January 25, the cash dividend will flow into Michelle’s account, and her paid dividend will match her earned dividend.
How do dividends work in your M1 portfolio?
If you’re ready to explore dividend stocks, you can create a custom Pie that includes dividend ETFs and/or companies that issue dividends. You can also keep it simple by investing in an expert M1 Dividend Pie.
If you’re already investing in dividends, tracking them on the M1 app requires a few simple steps:
- Login to your account.
- Click the “Invest” tile.
- Select the three lines on the top left corner.
- Click the “Activity” tab.
- Select “Filter,” then “Activity,” and filter out the other activity types.
For more information on viewing dividends, visit our Help Center.
Once you’re invest in and track dividend stocks, remember to maximize the wealth-building potential. You can automatically reinvest any earnings on the M1 platform by keeping your auto-invest toggle on.
When a company pays you a dividend, the cash will be deposited directly into your M1 Invest account. If you have auto-invest on and a dividend payment causes your cash balance to exceed $25, the entire cash balance will be automatically reinvested across your entire portfolio based on your portfolio targets. This makes your cash work for you, rather than sitting idly in your account.
Originally published March 18, 2018, updated May 20, 2022.