As I’ve mentioned, I recently began investing in the Vanguard 500 as an individual investor outside of the “walls” of a retirement plan. Prior to this, my experience with such plans was with retirement accounts: put in the money before it was even taxed, let it sit there and earn, and not really think about it. Now the situation is a bit different.
On Thursday, I checked my account and noticed that my number of shares had gone up by a fraction of a share. I looked around a bit and noticed that I had been paid a dividend, which I had instructed to be rolled over into more shares of the Vanguard 500. It was a small amount, but still quite interesting, so I began to research how dividends work. You’ll either find this information painfully basic or interesting, depending on where you are in your investments.
Dividends are monies paid out by companies to their shareholders out of their after-tax profits. Basically, if you own a share of stock in a company and they pay a $0.20 dividend, you get $0.20. Pretty basic. In a mutual fund, you get a dividend based on the combined dividends of all stocks owned by the fund; the fund adds up all of the dividends it earns, then divides it by the number of shares of the fund outstanding. Thus, for a Vanguard 500 share this month, the dividend was $0.65.
Most countries tax dividends, but at a lower rate than normal income tax. The reason for this is that any taxes on dividends are in fact a double tax: the dividend money has already had taxes paid on it by the corporation. In the United States, the dividend tax is currently 15% for almost everyone, so I’ll have to pay a very tiny dividend tax this year (a few dollars).
In the United States, dividends are usually paid out quarterly. Of course, quarterly merely means every three months, not necessarily the same day for every company. Most mutual funds seem to pay dividends near the end of a calendar quarter, thus dividends appear near the ends of March, June, September, and December.
I won’t get into the business implications of whether or not to pay out a dividend or how much of a dividend to pay other than to say there are widely different philosophies and thus different stocks that seem to have roughly the same value may pay dividends at wildly different rates.
I could also see that a frugal investor could end up with several million in stocks and could use the dividends to cover living expenses, particularly if they focused on buying stocks that paid good dividends. This, presumably, is yet another way for your money to make money for you.