What Is the Relevance of Dividends?
As a stock investor, a portion of the company's earnings belong to you. Some companies choose to distribute at least a portion of their earnings directly to investors in the form of cash dividend payments. When a company pays a dividend, they write you a check, giving you money for each share of stock you own. Dividends can be relevant to your investing success.
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Steady Investor Returns
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Over time, stocks have historically earned investors the highest average returns of all major investment classes. However, from one year to the next, stock prices can be volatile and investors can lose money. When a company pays dividends, however, you can earn a return on your money even during down stock market years. For instance, between 2000 and 2010, dividends accounted for 87 percent of investor returns in the S&P 500 index, according to Seeking Alpha.
Income
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Many investors invest their money to earn an income. This is especially true if you are retired or nearing retirement age. When a company pays dividends, it typically sends you a check four times per year, providing you with a steady source of income.
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Risk Reduction
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When you buy shares of stock, your risk is your original investment, or your cost basis. When you earn dividends, your cost basis is reduced by the amount of the dividend. Each time the company cuts you a dividend check, it reduces your total cash investment in the company because it is returning cash to you.
Dividends Have Tax Consequences
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When a company pays you a dividend on your stock shares, it creates a tax liability for you during the year you earned the dividend. Dividends and capital gains are treated separately when it comes to taxes. If your stock price grows after you buy it, you do not have to pay tax on your gains until you actually sell the stock. When you earn dividends, however, you have to pay tax during the year you earned the dividends.
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References
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