www.scantips.com

Withdrawing dividends is a poor investment plan

Dividend is a withdrawal, NOT new income

A menu into this page:

Withdrawing Dividends has a High Cost

How Stock and Fund dividends Work

How you CAN reinvest stock dividends

Confusion appearing to call Dividends Income

Hard Evidence a Dividend Payment does cause a investment price drop

If you might imagine stock and fund dividends are a new free gift to be withdrawn, then you really should read the following explanation about how that Not true, and withdrawal is very counter productive, and how stock or fund dividend reinvestment is extremely important instead. This is about all stock and fund dividends (but directly owned bond dividends are different, and instead do pay interest.) If not obvious at your broker, see how you CAN reinvest stock dividends below.

Stock dividends come out of earned money you already owned in the stock value, but when distributed to you, it was subtracted from your stock value, becoming withdrawn cash. The share count remains the same, but instead it drops the stock share price (by the equal dollars per share as the dividend) because the money was removed from your stock. It's called a dividend, but the fact is it's just a withdrawn distribution from your investment, also reducing your investment's stock price in the same amount. This evidence is in the table here near page bottom. So you have absolutely no value change on that distribution day, except the dividend money is back in your pocket instead of still invested. And you do owe some tax on that withdrawn part now too. But your investment value is left reduced at every withdrawn dividend.

However reinvested dividends definitely can have considerable value, because if reinvested, it becomes additional free shares (free of any additional cost), which will increase future gains over the years, which is a quite huge effect long term. No additional cost means you already owned the dividend money, and refused the withdrawal, and put it back to still be invested. It was to have been just a withdrawal, NOT new income. My goal is to make a believer of you about this, so you won't waste future earnings by withdrawing the dividend.

That's pretty much the content of this page, but there is more detail below.

Again, if you instead put the money back by reinvesting the dividend, it returns the dollars of investment. It also provides a few additional free shares, usually every quarter, which compensates for the price drop. There is still no gain on that first day, it is just back to even again. However the earnings of additional shares every quarter are a mighty Big Deal to increase future earnings, year after year. And it is certainly a good thing to know.

Reinvesting Stock or Fund dividends (instead of any withdrawals) are very healthy for a growing investment. A few decades of growth will be all-important to retirement (so start young to avoid missing out on the years of compounding). The detail is below, but stock dividends are costly withdrawals, because it leaves less money to grow. You can easily put it back though, and then gains on reinvested dividends are compounded and keeps earning more future gains, continually. Any frequent withdrawal (of stock dividends or otherwise) can very seriously reduce future compounded gain earnings.

First Things First:   The Cost of Withdrawals

It's important to realize that Withdrawing Dividends is at high cost long term, which is no small matter. Not that the dividend is your choice, but the dividend payment is a withdrawal from your stock, reducing your investment, which if withdrawn can be costly, having a huge long term bad effect on the now smaller investment. However, you can instead simply put it back by reinvesting the dividend to retain the previous investment value, which then has the added big benefit of providing a few free additional shares every quarter.

See this calculated loss in a S&P 500 chart on the S&P calculator page, calculating the actual cost of withdrawing dividends from a S&P 500 Index fund. It computes past S&P history of $25,000 invested for up to 50 of the past years. The S&P 500 dividend for the past 50 years has averaged around 2.8% a year, and is about 1.7% currently. That may sound small and insignificant, but the years of compounding definitely is a huge advantage. However, withdrawing it becomes unimaginably costly over the years.

This loss is a long term thing, not so much in only a year or two, but withdrawing dividends can cost about 25% of the overall investment value after 25 years, and maybe 40% after 35 years, and about 60% of it after 45 years.

It seems obvious that the best retirement planning is to start a good investment as early as possible, and let it grow for as many years as possible, until the retirement time comes to start withdrawing it. The many years of compounding is the major part of the gains.

This article is about stock and fund dividends, including bond funds (but directly held bonds are different than stocks or funds). Resell value of bonds are affected by current interest rate changes for the new bonds, however it changes the value of existing bonds. But bonds that are purchased directly and held until maturity or until recalled are then redeemed at full face value, without value change. You should be very aware of the difference of buying bonds directly vs. bond funds. Directly held US government bonds can be purchased directly from the US treasury, and possibly through your own broker. But bonds held in a bond fund are a fund, not directly held. Any bonds that are sold prior to redemption do vary in price due to interest rate changes (because if interest rates have increased, the buyer also has other better options then). Bond dividends in funds could be reinvested to provide compounding, but the value of bonds in a fund are priced according to current interest rates. But yes, directly held bond dividends are income (but stock and fund dividends are mostly taxed as capital gains after the first year).

But stock and fund dividends when paid do automatically equally reduce a stocks price value remaining (because the company's value decreases when they pay out dividends — more below). Withdrawing stock dividends are the same as any other withdrawal, simply lowering the overall value remaining. However, stock dividends can be reinvested to retain the same investment value, and then, the additional shares will increase compounding of future earnings, which then becomes significant income long term.

Speaking here of STOCK dividends, and mutual fund dividends (which includes bond funds), but interest dividends from directly owned BONDS are a different story. Bonds pay an interest rate on the face price of the bond, and if held until maturity, they are redeemed at face value. But stock and fund dividends are subtracted from the value you already own. The stock company has earned profit, and you as an owner are receiving a distribution of profit from that stock you already own. The stock dividend is Not new income, but since it was withdrawn, it becomes your Realized Gain or Loss, and is then taxed (reinvested or not). A mutual fund owns many stocks or bonds, collecting all the dividends, and then issues their own dividend, withdrawn from the fund you own.

How Stock and Fund Dividends Work

Dividends are Not the same income thing as interest paid by banks or directly held bonds. You do need to realize that a stock dividend payment equally reduces the stock price (dollars per share). A stock dividend payment is simply a withdrawal, just a distribution to you of the earnings you already had invested, so it is NOT new gain. It is just new taxation. But reinvesting it does have a strong tangible benefit (free added shares, with money you already had invested).

This is determined by the 16th Amendment giving Congress the right to tax income, and the IRS rule 301. See Google for some history.

So before you withdraw the dividends, it's important to understand that whole picture. Any withdrawal reduces your investment, which reduces your future earnings.

A company's publicly held capitalized value is their number of their existing stock shares multiplied by the price of one share. Apple's value this way computes to be over $2 Trillion. The idea of the dividend is the company deciding to distribute some of the company profit to the stock owners (I suppose because it is going to be taxed anyway). The dividend money paid out (as a few dollars per share) was removed from the company's value, as a payment into your cash account. This distribution reduces the company's value by maybe many millions or more, so the stock price (which reflects the remaining value of the company) is automatically equally reduced by the same few dollars per share of the dividend that was paid. It is subtracted from the value of the stock you already own, by lowering the stock price the same dollars per share amount. Due to that corresponding stock price drop, the sum of your remaining stock value plus the paid dividend remains exactly the same sum as before the dividend, i.e., there is no gain or loss on that day (there are of course also the usual market price variations that day, but the dividend distribution did not affect the overall value). Yes, the stock price does drop equal to the dividend dollars per share, and the withdrawal reduces your stock investment, but you did not lose anything. It was just a redistribution, a withdrawal, decided by the company, not by you. There is no gain and no loss, at least Not from the dividend on that day, but it was a withdrawal and the investment is reduced, so there will be a future loss of earnings. The distribution was just from the company's stock value that you already owned before, but now is instead withdrawn and transferred to your cash.

If a stock with price $100 distributes a dividend of $1 per share
If Dividend is Withdrawn If Dividend is Reinvested
Stock price is now $99, and you do have the $1 per share dividend in your pocket, but the $1 per share reduced investment continues every quarter, compounding far less future earning long term.
This withdrawal is a big deal.
Stock price is now $99, but automatically putting the dividend back retains the same previous value again, also with additional FREE SHARES EACH QUARTER for years of greater earnings.
This compounding is a big deal.

An important tax term: Unrealized Gain. If you bought stock for $100 per share, and you've owned it awhile, and its price went up to $192, so you have a gain of $92 per share. But that is just on paper. It is yours but is in an account somewhere, and you don't actually have the money yet, and you have not paid tax on it yet, and its price is still varying. You don't know what its price might be when you might eventually withdraw it. So the term is that the gain was unrealized gain so far (you don't actually hold the money), and it is not taxed until you do eventually withdraw it, when you do Realize the gain, meaning you do take out the money then, and the gains are taxed then, and that withdrawn money is no longer in the investment. But the dividend technically was already automatically withdrawn and subtracted from your investment value. It was realized gain then, but you can put it back (called Reinvestment then) which maintains the original investment value. Then that same money you had converts to more FREE shares (at zero additional cost to you). Every quarter. That is a huge plus long term.

The U.S. Congress tax law taxes a dividend when it is distributed to you, regardless if it is to be reinvested or not. When a stock or fund dividend is distributed to you (subtracted from your stock value that you already own), it becomes "realized gain", because you do have the money received, and do owe the tax then (on its gains). Your remaining stock price dropped that day by the same dollars-per-share value as the distributed dividend, so it was simply a withdrawal and the remaining stock now has less value (leaving still same number of shares but at lower price). It's actually a very good thing for the investment if you simply put the money back into the stock by "reinvesting" it, when its lower price then generates free new shares at the lower price, which will then (on that dividend day) be more shares at lower price for same prior value (then on that day causes no change in same prior total value if reinvested), but it is additional free shares for greater future gains). The new dividend increase your Cost Basis (so that money is not taxed again in the future).

Yes, your reinvestment did buy the dividend's shares, but with the same money you already had, which had just been withdrawn from your same stock. Reinvestment puts it back, maintaining the same investment value, and becoming additional shares, FREE shares because no additional cost. Assuming no other market changes that day, the value of your investment did Not change yet, but your number of shares did increase (probably every quarter), and the future gains will increase significantly. Reinvestment is a drastic long term benefit.

Regardless if reinvested or withdrawn, you do owe tax then on the dividend. If reinvested, it is a new purchase (which is added to your cost basis), which restores the exact previous restored value, so there is no gain and no loss of stock value on that day, but it does add a few additional free shares (at the lower price, which is same prior value, but at no additional cost to you). This normally occurs every quarter, and the future compounding really adds up long term.

Of course, the regular market price variations that day do still occur, but reinvesting the dividend itself causes no value change. But NOT reinvesting it does, withdrawing it reduces the value of the existing stock by the same withdrawn dollar value.

If it might help to encourage your dividend reinvestment, think of it as dollar cost averaging, which it is, and is a good plan. But it also retains your investment value, and is additional Free Shares

My own term: "Free" reinvested shares from dividends. You do spend your withdrawn dividend money buying the reinvested shares, but it is Not new money. It is money just withdrawn from your previous investment that you had already had. The share price was reduced an equal amount of the dividend, dollars per share. Reinvesting the dividend simply puts back the same withdrawal. The price is a bit lower then, but it buys a few more shares than you had before, so that on that day, you still have exactly the same previous investment in dollars (slightly lower price but a few more shares to be exactly the same prior value). Due to the price drop, the dividend bought more new shares at the lower price, so it's more shares than you had before, additional shares without any new monetary investment. That creates some new Free shares. Specifically, if the quarterly dividend is 1% of price, then you get 1% new free shares that quarter. There are 120 quarters in 30 years, making the long term compounding be dramatically impressive. But withdrawing the dividends is oppositely dramatic in it's own way.

Yes, the new shares are a bit lower price that day (reduced by the same dividend dollars per share that were withdrawn). Due to returning the dividend, you might debate how free, but on that reinvestment first day, you do still have the same stock dollar value as before, with the same investment total dollar cost, but also a few more shares that are cost free. They should gain back the price difference soon, but you will have the extra shares as long as you hold the stock. That's more shares to grow in the future, which will soon be a big plus. It may sound small and minor, but look at the withdrawal cost table at this page top. You may not like the price being lowered, but that is just today, and if reinvested, you do still have the same dollar value (and a few free shares). So just wait a week or so, and you'll likely be happier.

How You CAN Reinvest Stock Dividends

The way to reinvest regular stock dividends may not be obvious at some brokers, but it often can be done.

If the dividend was $1.60 per share, and you had 100 shares, then that dividend is $160. If the (then reduced) stock price is $60 per share, $160 reinvested would buy 2.6667 more shares. Mutual funds easily handle reinvestment of such fractional shares, but individual stocks do not. Stock exchanges work with whole shares, and strongly prefer lots in multiples of 100 shares. They have no option to trade fractional shares.

However, there is usually a way, at least for popular stocks. Most brokers now do offer a stock dividend reinvest option. They put your reinvested dividend amount into a mini-fund containing only that one specific stock. It is commonly commission-free. You don't see that brokerage mini-fund directly, but your stock account shows the 102.6667 shares then, and repeats grow the shares each quarter. When you do sell it, the broker will do the two transactions, and it works out, same as expected. So yes, stocks can have the option to immediately reinvest dividends. For example, here is Vanguard's description offering reinvesting stock dividends. They and others do offer dividend reinvestment of stocks, and may be already automatically included for an IRA or 401K account (withdrawals could cause a penalty). Reinvesting all dividends will increase your compounded long term growth.

I think Fidelity and Schwab initially make it plainer, but if you don't find the method to reinvest stock dividends, then ask your broker about it.

My purpose here is to emphasize that it's a seriously costly mistake to think of stock or fund dividends as New income to be withdrawn. The dividend is just a withdrawal of previous gains, which reduces your fund's value and its future gain potential. The withdrawal changes Unrealized Gain to be Realized Gain which is then taxed as income, but it NOT new income. Withdrawal makes it be Realized income (moving it into cash in your hand). I suspect many people interested in dividends have not thought about how it works and the effect of it. If you might be withdrawing stock or fund dividends, I hope you will rethink it. The dividend is certainly Not a gift to you, it is a distribution, simply a withdrawal from your own stock investment into your withdrawn cash (Realized Gain). If you are withdrawing when in retirement, then withdrawal was the planned goal, but if your earlier investment is still growing, the reinvestment gain can become huge over the years (or the withdrawal loss also huge).

The stock dividend simply transfers it from your stock into your cash account, which then reduces the stock price equally (same dollars per share as the dividend), so the smaller remaining investment in the stock has less value now, but you do have the cash difference. So there is no gain or loss, yet. Imagining the dividend is a gift of new income to be withdrawn is very wrong, it is simply a withdrawal from your stock, which equally reduces the value of your remaining investment. If you want to maintain the prior invested value, you can put it back by reinvesting the dividend. Reinvesting buys more shares, which is also a few more free shares than you had before. Then the current and prior total value sums are the same (no change in value on that day), but future gains do have more shares working after each reinvested dividend, which is a pretty big deal. This reinvestment purchase is added to your cost basis, so you don't pay tax twice on the dividend.

Confusion appearing to call Dividend Withdrawal "Income"

Don't be confused by a couple of things that might superficially make it sound like dividends are new additional income, but which it absolutely is NOT. Dividends are just a withdrawal of earnings you already had. Reinvestment will put it back, with a few new free shares.

The absolute best and most optimal way to seriously maximize long term income is to always reinvest that dividend. Putting the money back into the investment retains the previous stock investment value, and it will also generate some additional free shares for greater future compounded growth. That provides a very major income increase in the long term value. That's important, and very valuable long term, so don't miss seeing the withdrawal chart above.

I'd guess withdrawn dividend money likely just gets spent. But reinvested dividends increase continued compounded gains, for years.

A stock's dividend does not pay a fixed rate (not some % a year, not like bonds). The company simply decides how much profit dollars (if any) they will distribute to the owners, so they decide and declare some amount of dollars per share to distribute. Investors then may like to compare that as a percentage of stock price, but the stock price varies every day, so the dividend percentage varies every day too (but the dollars paid stays fixed). A popular method for the long term is to compute percentage from (the years total dividend dollars) / (the year end stock close price). Some companies pay no dividend, preferring to use the profit cash to fund future growth.

The returned dividend cash withdrawal is now in your direct control, cash which you can either keep or reinvest for additional shares of stock at the lower price, which means a few more shares than before. It is Free additional shares, meaning no additional cost than you already had invested before.. The increased shares and the lower price computes to be exactly the same previous value on that first day. So your account's value change due to that reinvested dividend distribution is still zero difference on that first day. It was just a withdrawal that if it is put back (reinvested), it retains the same value. You do pay tax on that withdrawal (reinvested or not), but then the reinvestment purchase is added to your cost basis so you will not pay tax on that dividend part again.

So what's the point? Reinvested or not, there is no overall value change on that dividend day, but your investment itself decreases when the dividend is withdrawn, but not reinvested. If it is a good investment, then of course, the optimum thing to do is to reinvest that dividend to maintain the investment value, and it will also become additional shares for free, every year. That is future gain offered if you want it, and the Big Deal is that your additional shares (received and reinvested usually four times a year) are now greater future investment gain opportunity. This additional gain is not large for just a year or two, but it becomes huge compounded over the long term years. If dividend is reinvested, then you will have additional shares for the same original investment cost. If each quarterly dividend was say $250, four times is $1000 a year of additional shares invested every year, which is compounded growth. But if that dividend cash is instead withdrawn, it has no future growth possibility, at least not in this stock or fund. It was only a direct withdrawal subtracting from your existing value. Withdrawing the dividend cash is a loss of that opportunity for much greater gain. That cost is relatively small over only a couple of years, but the loss of compounding over a few decades is a major cost of the vast majority of the investment potential. The table above shows that withdrawal cost.

But bottom line is that reinvestment of dividends is free additional shares four times a year which will have a huge impact on decades of future earnings.

There is only this one correct way to view stock dividends. Dividends are subtracted from your own stock value you already owned (from the stock's value). Any withdrawal is just subtracted from the stock or fund value. The dividend withdrawal is taxed then, but it is NOT new gain, it is merely realized gain of cash withdrawal (same as any other withdrawal).

So withdrawing dividends would clearly seem a big long term investment mistake, to be only just a simple direct withdrawal that reduces both your current and future fund value (again, same as any other withdrawal). The dividend percentage might sound small and insignificant, but it is HUGE when reinvested and compounded every year for a few decades. There's a chart on the S&P calculator page showing the devastating huge long term loss of withdrawing dividends in an example with a S&P 500 Index fund. Stock Dividends are valuable because reinvestment offers additional free shares, but withdrawing it is just a withdrawal from the fund, and is NOT new income (free meaning no additional cost than what you already had invested before).

The share price drop of a small dividend may be hard to notice in the numbers, but a large dividend (perhaps 6% or 8% paid only once a year in December, for example, TWCIX or VGHAX), may be called Capital Gain instead of Dividend, but same thing, both are withdrawals which can drop your favorite stock price enough to be very noticeable that day. But that price drop simply means that the dividend was paid. If you reinvest the dividend, your stock or fund will still have the same value, and also a few more shares (if reinvested, then still exactly same value on that day despite the lower price). There is no devious plan doing this, but yes, the price is automatically adjusted down, same as is done in events such as splits. Because the companies value does drop by the paid out dividend, which might be $Billions for the companies, so their remaining value did seriously drop. But you do now also have that dividend, and this is really just market action, since the stock no longer promises to pay the dividend already received by the owners, and new buyers will not bid higher to include it. True of every stock and fund that pays a dividend (and even bond funds paying interest). Any dividend lowers the price that day, so the dividend is Not income on that day. But dividend reinvestment does add a few shares (often four times every year) which certainly increases long term compounding of future gains.

You might think that since you have to pay tax anyway on the dividend paid this year, you might as well withdraw it. That might make some sense during retirement if you are withdrawing living expenses anyway, but dividends are NOT income that day, it is just withdrawn investment already owned. It is simply a withdrawal of fund value then, so the stock or fund drops that much too. But if reinvested, the overall value remains unchanged on that day (more detail below), but in the long run (without withdrawals), it is more shares which can in fact earn more, and the compounding of the additional reinvested shares (often four times a year, every year) will be a real earnings payback in the future.

Stock and fund dividends (including bond funds) are different than direct bond dividends.

There are about 66 stocks referred to as Aristocrat Stocks, which to be included in their list, the companies must be in the S&P 500 (largest US companies), and must have increased their dividend every year for 25 years, a point of pride indicating a stable business. See that Aristocrat Stocks list. But their annual increases can be small, and about half of them still pay less than 2.5% dividends (per year), and a few of those still pay less than 1%. Their average dividend is about 2.25%, but they do increase somewhat every year. If searching for high dividends, do also check for Total Return % too, because some have negative fund gains.

Summary of Dividend Payment Details

Many probably don't understand market dividends correctly or completely, but they ought to make the effort.

Near 80% of the S&P 500 companies pay dividends in some degree. See a list of these ranked by dividend (however the dividend is "dollars per share", so the percentage number also depends on current price, which routinely changes a bit every day). If interested in high dividends, you should also check out the performance of that ticker too, high dividend does not mean high performance. The S&P 500 index funds distribute that S&P 500 dividend proportionately into your fund shares. You might not even realize you are getting a dividend, but if reinvestment is not already set up, it should appear in your account in your brokers settlement money market fund. That would be withdrawals that reduce your stock investment value.

Don't misunderstand, reinvested dividends are very valuable, and definitely are a huge contribution to future long term income. Maybe not on first day, but if reinvested, they continually buy more shares each year which will compound additional future earnings extremely significantly. But if you withdraw the dividends, there was No income due to the price drop. You withdraw not only the dividend (which is a tiny part of the overall loss coming), but also and most importantly, the loss of their future earnings is repeated every year instead of being compounded year after year, which would have built to a vastly larger value. If you withdraw the dividends, it was simply a withdrawal, a distribution of your own money already earned.

Hard Evidence That a Dividend Payment Drops Stock Price

We pay income tax on the Realized dividend in the current year, regardless if withdrawn or reinvested. That is just a detail of congressional law which requires it. And since tax on the dividend will be paid, buying stock with any tax paid reinvested dividends increases cost basis, compensating by lowering the final taxable value when sold. Since 2012, the brokerages are required to keep track of dividends reinvested (adds to cost basis), but unknown cost basis due to older past reinvested dividends would be a tax problem when selling older investments. Tax on the compounded final result would be paid when sold.

The dividend price drop is real, well known, and automatic. Stock prices vary every day, which can obscure the dividend price drop. So it may be hard for market beginners to believe that the dividend drops price (with zero income gain) on the day dividends are paid, reinvested or not. I'll try to help show it clearly does drop, which produces zero dividend income on that day. For clear factual evidence of the price drop, just look at the stock or fund stock price history (those that show this detail), for example these several examples are from historical stock prices on Yahoo Finance (but not all stocks show the full detail). More recent occurrences should also show the same thing.

Yahoo Finance stock history
DateOpenHighLowCloseAdjusted
Close
Vanguard S&P 500 Index fund VFIAX
May 17, 2023312.29314.43310.74314.00314.00
May 17, 2023$0.68 Dividend
May 16, 2023309.83313.71309.83311.74311.06
311.74 - 0.68 = $311.06
Nvidia NVDA
Jun 07, 2023389.15394.99373.56374.75374.75
Jun 07, 2023$0.04 Dividend
Jun 06, 2023388.30391.60381.48386.54386.50
386.54 - 0.04 = $386.50
Apple AAPL
Feb 10, 2023151.34149.22151.01149.22157.28
Feb 10, 2023$0.23 Dividend
Feb 09, 2023153.78154.33150.42150.87150.64
150.87 - 0.23 = $150.64
Microsoft MSFT
Feb 15, 2023268.32270.73266.18269.32269.32
Feb 15, 2023$0.68 Dividend
Feb 14, 2023272.67274.97269.28272.17271.49
272.17 - 0.68 = $271.49
Vanguard Intermediate-Term Bonds VFIDX
Feb 28, 20238.348.348.348.348.34
Feb 28, 2023$0.025 Dividend
Feb 27, 20238.338.338.338.338.30
Bond funds also   8.33 - 0.025 = $8.30
Vanguard Health Care VGHAX
Dec 28, 202288.7188.7188.7188.7188.71
Dec 28, 2022$0.681 Dividend
Dec 28, 2022$0.987 Capital Gain Dividend
Dec 27, 202290.9090.9090.9090.9089.23
90.90 - 1.668 = $88.23
American Century TWCIX
Dec 21, 202276.8276.8276.8276.8276.82
Dec 21, 20220 Dividend
Dec 21, 2022$7.799 Capital Gain Dividend
Dec 20, 202283.3683.3683.3683.3675.56
A big change gets noticed:  83.36 - 7.799 = $75.56

Not all stocks show the full detail in this same way, but nevertheless, the price drop still happens. Stock dividends are taxed as a realized distribution, mostly Capital Gain (meaning gains taxed at a lower rate, if after 60 days, per USA IRS tax rules).

The dividend cash is transferred to you, as a withdrawal from your stock or fund value (including bond funds, but directly held bonds instead pay interest, like a bank). If you are in retirement, you might figure that since you pay tax on it, you might as well keep it, but the stock account does go down, and retirement can last many years. You can put it back by reinvesting it (especially if in a fund). Automatic reinvestment same day retains exactly the same previous stock dollar value, but at a lower price, and with a few extra free shares and a higher cost basis. And the next day opening may have other routine regular market price changes overnight too. You likely may notice the price drop in the larger cases, but it just means the dividend was paid.

This data in my table here is not updated very often to a later date, but it would remain the same point. The stock price changes a bit every day too, but on the day of the dividend, the "Adjusted Close" price simply subtracts the exact dividend from the Close Price. The dividend is the difference, and withdrawal changes that portion from unrealized gain to realized gain (which is taxed now). You can pocket it or put it back by reinvesting it. Reinvesting it becomes free shares. Yes, you did just buy them, but with money you just withdrew from the same stock and put back, so the difference is that you still have the same prior stock value, but more shares now (of the same value and at no extra cost, and you do owe some tax on the dividend now).

The fund price drops because the paid out dividend reduces the remaining value of the company. The prices of the company stocks in the fund are dropped (those that paid a dividend). In your view, the money simply transferred from the stocks you own to the cash now in your account, so your own value did not change on that day, but there was no gain either. On that dividend day, this becomes the stocks actual effective Close price. Other overnight market action can affect the next stock Open price too. However a mutual fund technically does not have an Open price, since it can only be bought or sold at the new Close price each evening day (with the exception of the new ETF funds which are regularly traded when the market is open). In these example instances, the stocks did also change a little more overnight until next day, but the idea about dividends is in the Close price.

There are differences in this reporting style among various funds and stocks. Some do not even show this added detail, but it is still present. Or there can be other factors, like stock splits in companies in the fund. Plus, the 500 individual S&P 500 fund companies may pay their dividend at various dates different than the S&P 500 fund passes the total along. In some cases you might notice that the Adjusted Close price drop does not exactly match the dividend subtraction. There can be other causes for price adjustment (splits, buying or spinning off other companies, etc), but the stated dividend amount shown is in fact reported correct, and that it includes the Capital Gains portion of the dividend. Most historical results are correct and complete, especially the adjusted price, but I've seen a few cases that the dividend value shown did not include the capital gains portion of the dividend. A part of the dividend is often taxed as capital gains, and the rest is called Dividend, which must be what sometime confuses their computer, but the actual dividend is the total of the parts. Even if the dividend value is not reported correctly, the adjusted close price should still be correct.

The Adjusted Close prices account for corporate actions like dividends, splits, spin offs (companies buying companies or selling divisions), or issuing or buying back shares. These are actions of individual companies, and a fund reflects the total. Some of these adjustment reasons affect all prior prices in the history. Here is a link to the math of Adjusted Close. Also other pages about Adjusted Close are found at Google. These clearly explain that dividends drop the share price equally. And of course, it does happen. Again, this is a known fact, and if a nonbeliever, I suggest seeing Google discussions about closing price adjustments.

So YOU should realize that the dividend is Not free money. It is Not New income, but is instead just a withdrawal from your previous stock investment that you already owned. The distribution simply moves some of it from a gain on paper to cash in your account, which is a withdrawal from the stock. Withdrawing the dividend (or any other regular withdrawal) is simply reducing your future investment opportunity potential, because withdrawing it has an amazingly large percentage cost (loss) over a few decades of investment. The term Dividend does not mean a new income source, but is instead just a distribution of the gain you had already received in the stock value. That received distribution reduces the remaining stock value, which you need to realize that. And realize that you can reinvest the dividend for a surprisingly greater future gain.

A mutual fund itself (other than ETF funds) is not bought by price bidding. ETF funds can be traded at market prices anytime the market is open. But a regular mutual fund only has one computed value once a day after market close, which is its only price until the next close. A mutual fund cannot be bought or sold until the next close and then at its price. This dividend price reduction effect is said due to the value of companies in the fund, but that price only depends on what buyers are willing to pay. But dividends do lower the value of the paying companies, which in turn automatically lowers the stock or fund price.

The dividend (the gain portion of it) is taxed as if income, reinvested or not. Reinvested dividends are added to the fund Cost Basis (more shares are bought at the reduced price), so the cost basis does reduce future tax when sold (so the dividend is not taxed twice). The reinvested dividend is added to future price gains when reporting fund total return. Sure sounds like income, but look at the details that actually happen, and it cannot be found. On the day the dividend is paid, the stock or fund price is immediately adjusted down equally (so there was no income yet).

Reinvesting the dividend does buy more shares which will earn additional growth in the future, which is a big plus... the reduced price will recover and growth will be greater with more reinvested shares, as it accumulates and compounds (which is income then). That does not correct the situation, it simply ignores it. But if the dividend is instead withdrawn on that first day, then there is no additional gain, not on that day or any day. It was then just a withdrawal, different in that it leaves all of the same previous shares but at the lower price (whereas ordinary withdrawals reduce the shares but don't affect the price. However the effect on fund value is the same). So don't withdraw the dividends imagining it was income. Reinvest it for greater future growth, which in time will increase income.

Copyright © 2021-2024 by Wayne Fulton - All rights are reserved.

Previous Menu Next