What is a dividend?

1 min readLast updated October 6, 2023by Rachel Carey

When you buy stocks, you are buying a share of any of the future profits they make. These pay in dividends – a portion of a business’s profits given to investors as a reward. But from ensuring your dividends are tax-efficient to even calculating what you can expect, there are some important things to be aware of when it comes to dividends.

What is a dividend? 

When a business welcomes new investments, you may decide to invest in that firm’s stocks or shares. Should the company perform well during a business quarter and create profits, you may be entitled to a share of these profits.  

This is called a dividend. It is a company’s way of rewarding investors for backing them and helping them to grow. Not every business issues dividends, and not all are paid in cash. Even for businesses that want to pay dividends, should the business underperform, there is no guarantee of receiving dividends.  

The amount of money you receive is based on the amount you have invested—investors with the largest investments in a business inevitably receive more dividends and, therefore, more rewards. The amount paid out through dividends is also subject to approval by the board of directors, which can change the amount distributed.  

It isn’t always businesses that pay dividends either. Exchange Mutual Funds (ETFs) and various mutual funds also pay dividends. Often, this is how these funds pay out interest to depositors, so it’s important not to always equate dividends with being the result of good performance.  

What are qualified dividends? 

When you receive dividends, they are considered part of your income. As a result, ordinary dividends can push you into a higher income tax bracket and be taxed at significantly higher rates. But under some circumstances, ordinary dividends can be treated as an investment that has appreciated – or a capital gain. In this case, a qualified dividend can be taxed at a maximum rate of 20 percent.  

To qualify a dividend, it’s important to know your ex-dividend date. This is the day before a dividend’s record date – when a shareholder must be on a company’s board to receive a dividend. To qualify an ordinary dividend, you must have held stock in a company for at least 60 days in the 121-day period that began 60 days before the ex-dividend date. In other words, count back 60 days from your ex-dividend date. In the 121 days before these 60 days, you must have owned stock in the company for at least 60 days.  

Dividends must also have been paid by a US or qualified foreign company, must not be disqualified from being qualified dividends by the IRS, and must have met the dividend holding period. 

Why are dividends attractive? 

Dividends are attractive to both investors and businesses for a few reasons. On the one hand, businesses paying out quarterly dividends are usually in good shape and can reward their investors with regular returns. This can, in turn, encourage more investors to invest in the future, helping the business grow.  

But dividends can also be an important part of an investor’s portfolio. While it’s true dividends don’t always deliver stable returns and can vary from quarter to quarter, they can be a regular source of income for investors. As mentioned above, they can also be highly tax efficient through qualified dividends. As part of a diversified portfolio, dividends can be a good source of income.  

How do you calculate a dividend? 

The dividend yield calculates how much investors will receive based on the stock price. In essence, this calculation can be done differently based on how often a business pays dividends.  

The easiest way to calculate the dividend yield based on quarterly payments is to divide the annual dividends per share or stock by the current share price. For example, if a business’s dividend per share is $5 and its current share price is $250, its dividend yield will be 0.02 – or two percent.  

What alternatives are there to dividends? 

Most businesses that pay dividends are mature businesses with stable enough profits to attract investors. Many businesses are not like this and will reward investors with alternative payouts, such as a stock dividend rather than a cash one. Other businesses may instead retain their earnings to reinvest back into business growth. 

How to buy dividend-paying investments 

A few different investments pay dividends, including stocks, mutual funds and ETFs, so depending on your risk appetite, you may find these attractive investment options. You must also identify which stocks or funds typically pay out the dividends you seek. But when comparing returns, thoroughly research your options, as high dividends don’t always mean good performance.  

The dividend yield can help you calculate the rough returns each investment may make for you, with any returns between two and six percent being a good option. Remember that dividends can be higher due to investors selling their stocks, so be sure to carry out plenty of due diligence.  

You should also consider the impact dividends will have on your tax bracket. As mentioned above, long-term planning can help you minimize the tax burden on your investments, particularly if you are already in a higher tax bracket.  

When you’re ready to invest, you can use a range of platforms, apps, and tools to make investments. Be sure to check the platform’s fees, as these can leave you less money than planned.  

Dividends can be an important source of income for your investment portfolio. But from qualifying your dividends to ensuring they are tax-efficient, speaking to a financial advisor can help you maximize your investments. Find your next advisor on Unbiased

Senior Content Writer

Rachel Carey

Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.