Investors who like to buy and hold stocks that pay dividends are wise to research and learn how dividend dates work. Some people who buy stock try a dividend capture strategy, which is also referred to as buying the dividend. This plan can be risky, and there are tax issues that may arise.
- 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 knowledge of how dividend dates work.
- This can be a risky plan since the market typically prices in dividends. This pricing often results in a decrease in share prices equivalent to approximately the amount of the dividend.
The Basics of Dividends
Dividends are payments by firms to their shareholders. These payments, often made each quarter, can be in the form of cash or shares of stock. When a firm makes a profit, it can either retain earnings to reinvest in the firm or share the profits with the shareholders in the form of dividends.
Owners often have the option of having the payments put into their brokerage accounts as a cash payment (for income reasons) or to reinvest and buy more shares of the stock (for growth reasons).
Dividend Dates Explained
There are four vital dates to know with regard to dividends and investing in stocks and mutual funds.
- The declaration date: This is the date that the firm's board of directors reports that a dividend payment will be made. The board will also report the record date and the date of the payment.
- The ex-dividend date: This date is the first day on which new buyers of a stock will not receive the dividend. This day is often two trading days before the record because stocks settle three days after the trade. You may see this called a "T + 3" settlement period, which stands for "Trade date plus three." In short, any owners of the stock on the day before the ex-dividend date will receive the payment. The day prior to the ex-dividend is called the in-dividend date. For instance, if the ex-dividend date was today, and you sold your shares today, you would still receive the payment 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. Note that 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" period. What owners need to know is that if they sell shares just one day before the record date, they won't receive the payment. Their new shares may drop in price, but this depends on the timing.
- The payment date: The payment date is the date that the payments are often made in the form of checks or money credited to shareholders' accounts.
What Happens to the Stock Price on the Ex-Dividend Date
A stock's share price often goes down on the ex-dividend date by an amount roughly equal to the dividend paid. This occurs because a dividend is a decrease in the firm's assets and the adjusted share price will reflect this.
Dividend Capture Strategy: 'Buying the Dividend'
As you can guess, some stock buyers attempt market timing strategies with mutual funds or stocks by buying shares just prior to the ex-dividend date to capture the dividend. They may then sell shares shortly after they buy. This is called the dividend capture strategy. In other words, the investor "buys the dividend."
The dividend capture plan can be risky, even more so if you believe markets are mostly efficient. In other words, rather than using a hands-off approach to the stock market, buyers skirt around dates to attempt dividend capture and buy the dividend. Share prices can be pushed higher prior to the ex-dividend date in anticipation of the dividend, and the price often falls on or around the payment date. Therefore, the market has "priced in" the dividend, and no real gain occurs from a buyer's timing.
If a buyer buys the stock on or after the ex-dividend date, they will not get a payment even though they now own the stock. The seller of the stock receives that money. Timing matters with this plan.
The Bottom Line
Buyers who buy and hold stocks and mutual funds that pay dividends are wise to be aware of how they work. This includes the dividend dates, which define when and if owners qualify to receive the payment. Trying to time the purchase of dividend stocks or mutual funds can be risky and may not work out for all those who invest.