Dividend Basics

When you dive into the world of investing, there are countless terms that you need to understand. One of the most common is the dividend. If you’re considering investing some money in a company, it’s important to know what a dividend is, how it works and what it means for you.

What is a dividend?

Unlike many financial terms, dividends are fairly basic and don’t take much work to understand. According to Investopedia’s James Chen, dividends are the amount of a company’s profits that you earn as a shareholder. When you invest in a publicly-traded company by purchasing a number of shares, you technically own a part of the business. That means when the company makes money, you get a portion of those earnings, or a dividend.

How do dividends work?

As we stated, a dividend is a sum of money given to you by a company you’ve invested in based on the number of shares you own. Chen says that this payout traditionally comes in one of two forms: as cash or as additional stock in the company. Thankfully, calculating how much money or how many more shares you’re owed is pretty simple. U.S. News contributor Coryanne Hicks states that a company should tell you what percentage of your stock they’ll pay on when you invest. For instance, if you own 100 shares and the company pays out 10 cents per share, your dividend will be $10. Using the same numbers, if you choose to reinvest that sum, you won’t receive the $10, but you will now have 110 shares.

It’s also important to know that your dividend will depend heavily on the type of stocks you purchase. Hicks says that many companies offer common shares, preferred shares and bonds. As a bondholder, you have more sway with the business, and you’ll be paid before — and possibly more than — the other types of investors. Moving down the ladder, there are preferred shares and common stocks. There’s also something called a “special dividend,” which Hicks defines as a one-time bonus payment that you get in addition to your normal dividend if the company had a successful few months or is restructuring. Of course, as with all investing, there’s no guarantee that you’ll receive a payment at all.

What do dividends mean for you?

Now that you know the basics, it’s time to look at the tangible benefits of investing in dividend-paying stocks. According to Corryanne Hicks, purchasing stocks can have an incredibly positive long-term outcome, whether you’re just starting your professional life or preparing for retirement. If you’re young, she suggests that reinvesting your dividends gives you the opportunity to build your portfolio and compound your profits. If you’re ready to leave the workforce, you can schedule regular payments and essentially live off of the money you invested years ago.

The Balance’s Thomas Kenny also says that dividend-paying stocks — while less predictable than fixed-interest options — can pay out far more. Compared to  accounts at financial institutions or government-issued bonds, dividends can yield anywhere from 1.5 to five percent, making them an ideal option if you’re looking to maximize your income.

Investing in dividend-paying stocks is a great way to diversify your portfolio and build financial security for the future. For advice on how to buy shares in a company — and how to tell which options are favorable — speak with your trusted financial advisor.

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