Most companies pay cash dividends to their shareholders, but they can also ask investors to put their earnings back into the company through stock dividends. These payments work much the same, and the amount of profit being passed onto shareholders doesn't change. It's just a matter of whether the investor gets cash or shares in the firm.
Keep reading to learn more about how these cash and stock dividends are somewhat the same and how they differ.
What's the Difference Between Cash and Stock Dividends?
|Cash Dividend||Stock Dividend|
|Popularity||Most common||Less common|
|Risk||Risk-free||Risk tied to stock performance|
The purpose of a cash dividend is income. The cash payment goes right into the investor's pocket, often through the account they have set up through their broker. They can spend it any way they choose.
The need for firms to keep enough cash on hand each quarter to hand out profit payments to stockholders means they must maintain more stable earning structures. This subtly reminds the people at the top that they're there to produce wealth for the owners of the business, not just make their empire bigger.
It also tends to prevent the hoarding of cash that could be blown by a CEO feeling pressure to make a move or prove they can lead.
Stock payments, whether paid directly from the firm or put back into the firm by the investor, help grow investments. If an investor has faith in the long-term viability of the investment, they often prefer the growth opportunities in stock dividends.
The IRS reports that most dividends are paid out in cash. This is the most common way to pass profits onto stockholders. Still, cash dividends are less common in sectors and firms that focus more on growth than profit. These firms may reinvest their profits into growth or stock buybacks as opposed to dividends.
There aren't any special risks that come along with cash dividends because you're paid in cash. The only risk is the same risk of inflation that affects any cash savings you keep.
With stock payments, there are more risks to think about. If the stock price plummets after you're paid, then you would've made more money from a simple cash payout. However, this risk can also work to your benefit, just as with any other way you invest your money. If the stock price goes up after you receive your share of the profit, the payout can be higher than it would've been with a cash profit payment.
Which Is Right for You?
In most cases, you won't have a choice about how to receive your dividend. Also, keep in mind that these two options are alike. The income, whether it is cash or stocks, will be taxed as ordinary income at your normal income tax bracket rate unless the dividends are "qualified." Qualified dividends are those that come from U.S. firms whose stock you have owned for at least 61 days. These qualified dividends are taxed at a lower rate. Tax rates for them are either 0%, 15%, or 20%.
The real choice at hand is whether or not you will choose to reinvest your cash dividend or sell your stock payment for cash. Here are some factors to think about if you're unsure which choice is right for you.
When Cash Dividends Work Best
You might prefer a cash payment if you invest for income. You may also choose cash if you prefer to invest in some other venture.
Cash profit payments can be a great mental lift for people who own stock in a firm. Imagine a retired teacher living in the suburbs with a portfolio of $500,000. A major market drop of 20% would create a paper loss and create concern for the teacher, but maybe only if she had money in firms that didn't offer cash payouts. By getting some cash for a stock doing well, that teacher would know that she is still getting some reward from her money.
The same loss may not bother them if they were to invest in equities that brought them income, say with an average dividend yield of 4%. They would be pleased by the $20,000 cash payout from profits they receive each year. Getting part of the profits will help them feel like they have been given a stake in a profitable venture rather than a person subject to the whims of the stock market.
There are also times when stock payments may not be that good. If the stock is overvalued, you may want to hold onto cash dividends, even if you plan on reinvesting the money in the future.
When Stock Dividends Work Best
Investing is the process of laying out money today so that money will work for you not only now, but down the line for you and your loved ones in the future. Growth in the firm should result in future changes to your lifestyle, either in the form of nicer things or financial freedom.
If you're focused on growth and you have faith in the venture you've put your money into, then you may prefer to put your cash payout into more stock to add to your gains.
A Best-of-Both-Worlds Option
Rather than choosing between those two options, you might favor investing in a firm that rebuys shares to remove those shares from the market. This action will often increase the value of shares. Some of these firms may also offer dividends.
Share repurchases are a more tax-efficient way to return capital to shareholders because they won't have to pay taxes on those buybacks. Still, their equity in the firm goes up. This can result in more profit and cash payouts on your shares, even if overall sales or profits never increase.
The Bottom Line
Most people who get cash payouts will find them added to their brokerage account, rather than stock dividends that give out shares instead of cash payments. Still, if you would prefer stock dividends, you can buy more shares with the cash you receive. Some firms will buy back shares instead of paying dividends, which brings up the value of shares.
- You might prefer cash profit payouts if you're an investor who needs cash now to live or if you want to be sure you can put the excess profit where you want.
- You may want to invest money in a firm that rebuys its own shares if you think companies can create even larger profits by reinvesting to earn high returns on equity with little debt.
- If a firm issues cash payments but you'd prefer more shares, you can always reinvest your profit to replicate a stock dividend.