Investors who like to buy and hold dividend paying stocks are wise to understand how dividend dates work. Some investors attempt a dividend capture strategy, which is also referred to as buying the dividend. However, this strategy can be risky and there are tax consequences to know about.
- The dividend capture strategy involves buying a stock on or just before the ex-dividend date and then selling the stock after locking in the dividend payment.
- To capture dividends, an investor must have a strong understanding of how dividend dates work.
- This can be a risky strategy since the market typically prices in dividends—share prices will rise in the days leading up to an ex-dividend date and then fall afterward.
The Basics of Dividends
Dividends are payments by corporations to their shareholders. These payments, usually made on a quarterly basis, can be in the form of cash or shares of stock. When a corporation is profitable, it can either retain earnings to reinvest in the corporation or it can share profits with the owners (the shareholders, aka the investors) in the form of dividends .
Investors often have the option of receiving the dividends in their brokerage accounts as a cash payment (for income objectives) or to reinvest and buy more shares of the security (for growth objectives).
Dividend Dates Explained
There are four important dates to know and understand with regard to dividends and investing in stocks and mutual funds:
- The declaration date: The declaration date is the day that the corporation's Board of Directors announces its approval of a dividend payment. The Board will also announce the record date and the payment date of the dividend.
- The ex-dividend date: The ex-dividend date is the first day on which new buyers of a stock will not receive the dividend. This day is usually two trading days before the record date because stocks settle three days after the trade date (referred to as a "T + 3" settlement period for "Trade date plus three"). In short, any owners of the stock on the day before the ex-dividend date will receive the dividend. The day prior to ex-dividend is referred to as an in-dividend date. For example, if the ex-dividend date was today and you sold your shares today, you would still receive the dividend even though the sale won't settle for three days.
- The record date: The record date is the date after which new buyers of the shares will not qualify for the pending dividend payments. Remember, this date is a formality because an investor must buy shares prior to the ex-dividend date to own them by the record date because of the "T + 3" settlement period. What investors need to know is that if they sell shares just one day before the record date, they won't receive the dividend (although their new shares may drop in price, depending upon the timing).
- The payment date: The payment date is the date that the dividends are actually paid in the form of checks or credited to shareholders investment accounts.
What Happens to the Stock Price on the Ex-Dividend Date
A stock's share price usually decreases on the ex-dividend date by an amount roughly equal to the dividend paid because a dividend is a decrease in the company's assets and the adjusted share price will reflect this.
Dividend Capture Strategy: 'Buying the Dividend'
As you can imagine, some investors attempt market timing strategies with mutual funds or stocks by purchasing shares just prior to the ex-dividend date to receive the dividend. They may then sell shares shortly thereafter. This is referred to as the dividend capture strategy. In other words, the investor "buys the dividend."
The dividend capture strategy can be risky, especially if you believe markets are relatively efficient. In different words, other investors attempt the dividend capture strategy and buy the dividend. Share prices can be pushed higher prior to the ex-dividend date in anticipation of the dividend and the price normally falls on or around the payment date. Therefore, the market has "priced in" the dividend and no real advantage can be gained by an investor's timing.
Investors who buy and hold dividend paying stocks and dividend mutual funds are wise to understand how dividends work. This includes the dividend dates, which define when and if shareholders qualify to receive the dividend. Trying to time the purchase of dividend stocks or dividend mutual funds can be risky and may not be beneficial to investors.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.