Copyright © 2021-2025 by Wayne Fulton - All rights are reserved.
Dividends are NOT New Income, but merely a Forced Withdrawal
Withdrawing Dividends has a High Cost
How Stock and Fund dividends Work
But you CAN put it back by reinvesting stock dividends
Confusion appearing to call Dividends Income
Hard Evidence a Dividend withdrawal DOES cause a investment price drop
This subject is about all stock and fund dividends including bond funds. However dividends from directly owned bonds are very different, and instead do pay interest without reducing principle.
If you might think of stock and fund dividends as being a new free gift of additional income money, then you really should read the following explanation about how that IS FAR FROM TRUE. Withdrawing dividends is very COUNTERPRODUCTIVE to long term gains. The Big Deal is that stock DIVIDEND REINVESTMENT is extremely important instead.
STOCK AND FUND DIVIDENDS ARE NOT FREE NEW MONEY. It's important that you realize that stock and fund dividends are simply a forced withdrawal which comes out of your current investment. The dividend withdrawal equally reduces your investment, reducing all future earnings.
This is certainly NOT just my notion. It is well known and is just how it works. On the day of the dividend, the stock price is adjusted down by the same amount as the distributed dividend (per share). This is explained many places on the web (Google stock closing adjustments for dividends). However many investors seem to imagine that stock dividends are somehow new free gift income. But absolutely NOT SO, dividends are simply a withdrawal from your investment, which equally reduces your investment (which seriously reduces your compounded long term earnings).
However putting it back (reinvesting the dividend) does restore the previous investment, and in fact offers strong future gain benefits. The Dividend is NOT new income on its First Day, but long term, the reinvestment shares add larger gains every year for many years of compounded gain of free additional shares every quarter. That is then a Big Deal (long term) but a dividend is Not initially any new income on the first day.
See Investopedia's closing price adjustment explanation. Closing price adjustments can include stock splits, dividends, mergers and acquisitions, and other. It clearly says dividends are subtracted from closing price because that distribution amount is no longer part of the companies assets, however is part of the investor's returns (already earned, but now withdrawn as a distribution to you).
Visual evidence of this is in the Yahoo's table data near page bottom.
See the recent Morningstar article at There Is Nothing Special about Dividends (and other articles there).
One quote from its author Larry Swedroe (that I've also been trying to say here) is:
The problem is that dividends are NOT income (except for IRS purposes) they are RETURN OF CAPITAL and reduce your investment. Income increases net worth while dividends do not. This is just a fallacy yet conventional wisdom.
Meaning, some people do believe dividends are new gift income, but that is NOT true. Another Morningstar article you should see is What You’re Getting Wrong About Dividend Investing. The facts are very clear, that dividends are just a forced withdrawal that reduces your investment (every quarter).
If that's not clear, it means withdrawing your dividends is extremely counterproductive to long term gain, and you should rethink that.
But MOST IMPORTANT, you can put the dividend distribution BACK into the investment, by choosing what is called reinvesting the dividend. When the dividend is reinvested (put back), then the total investment value remains at the same value as before the dividend (unchanged on that day).
If you might not see an obvious way at your broker to reinvest stock dividends, see how you CAN reinvest stock dividends below.
The impressive large benefit of the dividend (none on first day, little the first few years, but huge long term after maybe 25 or 30 years of compounding for retirement) is that reinvestment will give you a few NEW FREE SHARES (free meaning no additional money added). The reinvestment bought shares (free to you, no additional cost) with the money previously withdrawn but put back, which exactly restores the previous value (that day) and also adds to cost basis like any new purchase. Those continued reinvestment shares give very strong gains when compounded long term, so reinvestment is definitely a plus. But there is still Zero value change on that first reinvestment day (other than to restore the previous value). Reinvesting dividends is an excellent plan for long term gain, but withdrawing dividends seriously reduces future gain.
Virtually everything we hear about dividends seem to call them income, which is simply very wrong (dividends are simply withdrawals from your investment, distributed from income earned already in the past). I've never understood why some favor buying stocks that pay large dividends (probably meaning more than 2% or 3% annually). It could be very different if the dividends were reinvested, but if withdrawn as income, that makes no sense since the withdrawals keep decreasing the investment value. They may like the dividends, but bemoan the stocks low price performance. So they should also pay attention to the investment's Total Return %. I suspect reinvestment is not their plan, but long term is certainly much better if always reinvesting the dividends (but again, better pay attention to the Total Return %). It may pay a good dividend, but might not have been a good stock investment.
So a dividend distribution causes absolutely no change to your overall value on that first distribution day, except:
And there are TWO good effects of reinvesting dividends. First it restores the previous value of course, and then those accumulated new shares will certainly create dramatically even more gain when compounded long term. The first few years may not show much yet, but the Free shares keep coming, and long term (hopefully like 20 to 30 years waiting for retirement) will be wonderful. You can of course continue adding new money to your investment too. But in contrast, withdrawing dividends is counterproductive and will limit modestly meager earnings. See below: Hard Evidence a Dividend withdrawal does cause a investment price drop
The slightly lower share price after dividend is mixed in with the regular market change on many days, and you probably never noticed the price drop then, but your investment did just suddenly have a bit more shares of advantage to you. The investment is the same market value that first day, but is repeated probably every quarter, and the long term compounding really adds up. But if instead withdrawn, it is very counterproductive to your earnings.
What you should know is that dividends that you withdraw do equally reduce your investment value (like any withdrawal, but you may not realize how drastic the continuous dividend withdrawal is), which reduces its future earnings of course. But you can properly instead fully restore the investment each time by specifying dividend reinvestment, which will then instead provide continuous increases which add additional increased future gains compounded long term. There are 120 quarters in 30 years.
For a better understanding of this real issue, there's a chart on the S&P calculator page showing the devastating huge long term cost (loss) of withdrawing dividends. The current data is back there, and it was also copied here on 1/24/2025. It uses actual real S&P 500 data (such as S&P 500 Index funds), actual real world history, showing calculated results of reinvesting dividends or not, on the real data. (WD here is Withdrawals.)
End date of each row is 2025 YTD.
| S&P 500 | No withdrawals | Overall Cost of Withdrawing all Dividends | |||||
|---|---|---|---|---|---|---|---|
| $25K Start | Years | Fund Value No WD | Dividends reinvested | Fund Value after WD | Dividends Withdrawn | End Value Fund + WD | Cost of Withdrawal |
| 2020 | 6 | $51,579 | $3,390 | $47,212 | $3,259 | $50,471 | 2.15% |
| 2010 | 16 | $187,719 | $24,607 | $136,787 | $20,292 | $157,079 | 16.32% |
| 2000 | 26 | $169,906 | $26,275 | $103,816 | $19,095 | $122,911 | 27.66% |
| 1990 | 36 | $932,504 | $159,163 | $431,610 | $92,078 | $523,688 | 43.84% |
| 1980 | 46 | $4,938,490 | $872,667 | $1,413,109 | $324,158 | $1,737,267 | 64.82% |
| 1970 | 56 | $8,784,071 | 1,566,134 | $1,656,865 | $391,527 | $2,048,392 | 76.68% |
Here are two obvious thoughts. Reinvest all dividends, they restore your investment value. And Two, start preparing retirement income a few decades early. Many long term years are your best investment tool.
Age 35 can do 30 years (to retirement at 65), and age 25 can do 40 years, if they are wise enough to start today. The young will learn, but often not soon enough. Older will need to provide more investment, still early and more money can be added all along. And it continues to gain during retirement withdrawals. Quarter after quarter, the withdrawn dividends reduce the fund's future gains, which then also seriously reduces your future long term net worth in retirement. But the quarter after quarter of reinvested dividends continue compounding the earnings. There are 120 quarters in 30 years.
These results are a one time 25K single investment, and in spite of 2000-2009 being a miserable decade in the market (it being down -9.5% at the end of the decade, no gain).
Reinvesting dividends long term (early enough) could provide a few million dollars long term, meaning preparing for your retirement when employment ends (which if wise, the easy way is to start NOW, TODAY, else the opportunity can be lost).
This should be clear about dividends, and all that is left is for you is to become a believer. To help that, it's still the content of the rest of this page, with more detail below.
Market stock prices of course go up and down every day, so the dividend reduction might not be noticeable, but you will certainly believe it if the stock pays a large dividend, like 6% or 8% once a year. Consider that to just to be notification the dividend was paid.
Reinvested dividends definitely can have considerable long term value, because if reinvested to put it back, 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.
Again, if you instead put the money back by reinvesting the withdrawn dividend, it restores 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.
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.
Dividends are Not the same income thing as interest paid by banks or money market 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 forced 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). And a dividend does increase cost basis, so you won't be taxed again on that money.
This is determined by the U.S. 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 $3 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 forced 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, restoring the previous investment value, and becoming additional shares, FREE shares because no additional cost, money that was already there before it was refunded. Assuming no other market changes that day, the value of your investment did Not change yet, but your number of shares did increase (repeated probably every quarter), which will increase the future gains significantly (long term, not much at first). Reinvestment offers a dramatic 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 value on that day due to the dividend (regardless if reinvested or not), but reinvestment does add a few additional free shares (at the reduced price), which creates the same prior value, but at no additional cost to you, and no gain yet that day). 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 withdrawing it reduces the value of the existing investment by the same withdrawn dollar value but the dividend is in your pocket, so no value change.
If it might help to encourage your dividend reinvestment, think of reinvestment as dollar cost averaging, which it is, and it's a good plan. It also retains your investment value that day, and is additional Free Shares
Maybe your income need is now, such as income during retirement, which is likely the purpose of that investment. But otherwise, unless dividends are reinvested, withdrawn dividends reduces your investment and future earnings. Whereas reinvesting them restores the current investment value, and each dividend also adds new free shares to significantly increase the future gains. It's about compounding.
If no dividend, the standard Fixed 10% earnings formula is:
1.101 = 1.10x initial value at 1 year.
1.1010 = 2.59x value at 10 years.
1.1020 = 6.73x value at 20 years.
1.1030 = 17.45x value at 30 years.
1.1040 = 45.26x value at 40 years.
The point is, the years do the compounding work, and exponential is dramatic, so start early. (see Compounding and Annualized Return and calculators).
If thinking the Rule of 72 might be of any concern here, it is only an approximation, dating back at least to the day of Columbus or before, when precise computing was quite difficult. The Rule of 72 shows the years required to double, but these examples are NOT about doubling the investment, so Rule of 72 is NOT even applicable.
FWIW, Rule 72 is the most accurate at 9 years, when 8.00597% is 2.0x gain (1.08005979 = 99.9999% gain and is Rule of 72.05377. See Rule of 72). But computers are the precise way now.
1.121 = 1.12x initial value at 1 year.
1.1210 = 3.11x value at 10 years.
1.1220 = 9.65x value at 20 years.
1.1230 = 29.96x value at 30 years.
1.1240 = 93.05x value at 40 years.
Dividends are typically paid each quarter, and this formula compounds annually, but still the same idea. The 12% approximately triples each 10 years. Which is a pretty good investment, and in 3 decades, 33 = 27x the initial investment. The S&P 500 index has done about this long term for at least the last 50 years. But it requires reinvestment of all dividends.
The reinvested 2% dividend increased earnings for 30 years by (29.96 - 17.45) / 17.45 = 0.717 = 71.7% more gain in 30 years long term (more than if no dividend to reinvest, and greatly more than if withdrawing the 2% dividend every year). Reinvesting the dividend back in has huge long term gain, because it keeps adding new free shares for the future. But on the day it is paid, the dividend is NOT new income, it is simply a withdrawal of previous gains you had already earned (withdrawal makes it be taxable "realized income"). The dividend withdrawal lowers the existing stock price by the same dollar amount, which lowers the invested value the same way. But you do have the dividend cash now, so in that way, your overall value on that day remains the same, but no longer invested the same way, reducing future gains.
1.081 = 1.08x initial value at 1 year.
1.0810 = 2.16x value at 10 years.
1.0820 = 4.66x value at 20 years.
1.0830 = 10.06x value at 30 years.
1.0840 = 21.72x value at 40 years.
You do also have the withdrawn 2% each year, but that is a very minor amount (it does not compound), and that withdrawal also reduces the future with 2% withdrawals. The 8% approximately doubles each 10 years, still much better than a bank, but which is drastically less long term than reinvesting offers.
The accumulated 2% dividends withdrawals are 0.02 × 30 years = 0.6x less cash, then totaling 10.66x value, still substantially less. The dividend withdrawals keep reducing the investment.
You might reinvest the dividend somewhere else so it compounds, but this example assumes you simply spent it as received. It's just a small amount each quarter so it may seem trivial, but I'm here to tell you that reinvesting eventually adds up in a very huge degree. In 30 years:
The 10.66x value is (10.66 - 17.45) / 17.45 = -0.389x or -38.9% less gain than if there were no dividend.
And (10.66 - 29.96) - 29.96 = -0.644 or -64.4% less earnings than if reinvestment.
If you are withdrawing dividends, I think the appropriate saying should be "Wake up, and pay attention". 😊 Reinvesting the dividends may be hardly noticeable short term, but is greatly more profitable long term.
Great exception is of course made for withdrawals starting during retirement, which is the expected purpose of the investment. It is the reinvestments until retirement that provide the years of greater growth then.
The dividend is NOT new income, but is just a withdrawal of prior earnings, but the continual withdrawals just keep on reducing the investment. But the reinvested dividend is a continual stream of additional free shares, which do earn considerably more, long term.
For a long term investment that offers dividends, ignoring dividend reinvestment seems an extremely costly and counterproductive plan. Any dividend decision needs to know that.
Dividend ReInvestmet Plans may be called DRIP. It's more difficult because the dividend dollars likely do not buy an even number of shares (likely some fractional remainder). So the way to reinvest regular stock dividends may not be obvious at some brokers, but still, it often can be done. However ETF (Exchange Traded Funds), which trade in whole shares, may not be eligible for reinvestment at all brokers.
Example: If the dividend was $1.60 per share, and you had 100 shares, then that dividend is $160. If the stock price had been $60 per share, now reduced to $58.40 price, $160 reinvested would buy $160 / $58.40 = 2.7397 more shares, which exactly restores the previous value (2.7397 shares x $58.40 = $160 value put back). 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. The market has no option to trade fractional shares.
However, there is usually a way, at least for popular stocks. Funds handle fractional shares already, but stocks don't. But most brokers now do offer a stock dividend reinvest option (called DRIP). They put your reinvested fractional share amount into a mini-fund containing only that one specific stock. It is commonly commission-free. There may be thousands of users with reinvested fractional shares of this one stock, so the sum combines to whole shares except for the remaining fraction of one share. You don't see that brokerage mini-fund directly, but your stock account shows the 102.7397 shares then. When you do sell it (if a stock), you sell the whole shares and then 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 (which have rules about early withdrawal penalties). Reinvesting all dividends will increase your compounded long term growth.
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 long term 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.
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, reducing your investment. That is NOT income, and NOT a plus. But reinvestment will put it back, as a few new free shares, becoming quite valuable compounded long term.
The dividend is taxed as income (as is any withdrawal), but the IRS (US tax agency) calls it income merely because it was withdrawn (but you can reinvest it). Any withdrawal changes it from unrealized gain into realized gain. That's a tax thing, since it is no longer invested earnings, but is now withdrawn earnings, which is now cash in your pocket.
This withdrawal reduces the stock investment remaining, reducing your future earnings. You can keep the dividend, or you can reinvest it, to put it back as a new purchase in the stock to equally restore the previous full value (which increases cost basis equally as a new purchase, a future tax benefit, because that part of the tax is paid). Either way, reinvested or not, the withdrawal is taxed as realized gain that you did withdraw. See just above for How you can reinvest stock dividends if any question.
Total Return % (like in Morningstar statistics) does add the dividend per share to the stock gain per share as the gain value received, reinvested or not. But that is just to compensate total earnings due to the price drop caused by the dividend withdrawal. You had already earned the dividend money, even if it was not yet realized (not in your pocket yet). Then the dividend distribution makes it realized (taxable income in your pocket) which distribution also does equally reduce the stock prices and your remaining investment value. But then you did receive your dividend so it totals the same.
Reinvested purchase is just like any new purchase, in that you buy more shares. But a dividend is investment money you had already earned, now withdrawn and distributed to you, so there is no new additional cost or gain of dividend reinvestment. Reinvestment simply puts it back and restores your full investment again. It buys more shares at the reduced price to keep your investment the same previous dollar value.
You could keep and spend the dividend, but reinvestment has these actions:
It provides a few more new free shares every quarter, drastically increasing long term compounded future gains.
The new shares restore your investments value to exactly equal value as before the withdrawal reduction.
So there is no cost or gain involved on that first day.
Morningstar statistics don't know of your actions, so they assume all dividends are reinvested back (because it was part of the stock's gain, and reinvestment is the proper way for them to report it, and for you to do it). Reinvestment simply restores your stock's prior earning value with a few extra free shares (each quarter).
The dividend distribution did return capital from your investment to you, but it is certainly Not new free income. It was already your own earned money, but just not withdrawn yet. The withdrawn dividend (per share) has just been equally subtracted from stock price, but the investment value can be restored by adding it back (via reinvestment), which then is in the form of a few new free shares (which certainly is a future advantage). The stock price did drop with the dividend withdrawal, but reinvesting dividends (at the lower price) adds shares to restore it to the same previous total value. Adding dividends back as new free shares now adds increased future performance. Dividends are part of the stock's Total Return value, but dividends are NOT NEW INCOME. It is withdrawn earnings. Keeping the dividend in your pocket does reduce the remaining investment, and then any future Total Return % statistics will not accurately apply to your reduced account then.
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.
Trying hard to make a believer of you. Because I'd guess withdrawn dividend money usually just gets spent. But reinvested dividends continually increase gains, every quarter for years. That compounding really adds up long term.
A stock's dividend does not pay a fixed rate (not some fixed % a year, not like bonds or banks). The stock's company simply decides how much profit dollars (if any) they will distribute to the stock owners, so they decide to 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 (called trailing dividend). 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 probably four times a year which will have a huge impact on decades of long term 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 new 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.
A fund holds stock and/or bonds from many companies or bond sources, so all the dividends are collected into the fund value, and the fund issues their own dividend, of which you get your fund shares proportion of it.
Either way, a dividend withdrawal reduces price, not shares. If the same dollar value is withdrawn, the resulting total dollar value (sum of remaining invested value plus withdrawn amount) on that first day is still exactly the same previous total sum, but you have it as cash now, no longer invested in the stock or fund value. You can keep the cash, or you can reinvest it. If you reinvest it on that same day, putting it back again restores the previous invested stock or fund value, with the lowered price, but with a few new additional free shares to be the same prior total.
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.
Stability is good, but be sure to check their Total Return % too, because paying the dividend reduces their stock value every quarter.
Many probably don't understand market dividends correctly or completely, but they ought to make the effort. And bond dividends are even more complicated, see Bonds.
Reinvesting the dividend puts back its value, keeping the account value the same. There is no dividend income on that day, it was already your money. However the big deal is that reinvesting dividends does buy new additional shares which will increase future gains. Compounded long term, that has a large effect on earning gains.
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.
We pay income tax on the distribution of dividend in the current year, regardless if withdrawn or reinvested. That's just a detail of congressional law which requires it for withdrawals. And since tax on the dividend will be paid, buying stock with any tax paid reinvested dividends beneficially adds to 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 realize that the dividend drops price (with zero income gain) on the day dividends are paid, reinvested or not. I can 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 dividend detail), for example these several examples are from the historical stock prices on Yahoo Finance.
Dividend distribution is subtracted from the investment, but can be put back by reinvestment. Yahoo Finance data shows the dividend subtraction in its Weekly data. Any statistics showing value gain percent assume dividend reinvestment.
Dividend distribution uses four decimal places to compute the shares, but is rounded to 2 places for dollars and cents. That rounding can sometimes see a penny or two difference (in a couple of cases here). There can also be other possible closing adjustments (like stock splits, return of capital, mergers and acquisitions for the various companies in a fund, sometimes adjusted every day, but dividends just one day).
Examples: See it for yourself. This data in my table here is not often updated to a later date, but it will still retain the same point. Even the days with no dividend can show other adjustments, splits and acquisitions and so forth. And for splits, ALL earlier data will be price adjusted too, to make comparisons possible. Or some stocks will have no adjustments or dividends.
The dividend dollar value distributed is shares × price before the dividend price reduction.
Reinvested shares are at the reduced price, which computes the same prior value, no value change on this first day.
But the dividend is just a withdrawal and a reduced investment, unless reinvested.
Not sure all stocks show the dividend detail in this same way, but nevertheless, the price drop still happens. Stock dividends are taxed as a realized distribution, mostly being Capital Gain (meaning mostly is taxed in USA at a lower rate, typically at 15% tax rate).
The stock market price changes a bit every day too, so the Weekly prices shown of Adjustment and Dividend do not precisely agree, but should still make the point. But on the day of the dividend, the "Adjusted Close" price simply subtracts the exact dividend from the Close Price. The dividend is that 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 (an option at your broker). Reinvesting it restores the investment value and becomes free shares. Yes, you did just buy them, but with money you just withdrew from the same stock and put back, so you still have the same prior stock value, but more shares now (at no extra cost, and you do owe some tax on the dividend now).
The dividend cash is transferred to you, as a withdrawal from your stock or fund value, including bond funds which do the same, but directly held bonds are very different, and instead pay interest, more like a bank, and do NOT reduce principle. Directly held bonds return original face value when redeemed at maturity. But bond fund values are an adjusted price when withdrawn which could be higher or lower, oppositely depending on if current interest rates. Bonds are more volatile than stocks, for different reasons with different rules. The stock market does not affect bonds, but current interest rate higher than the existing bond rate make the existing bond worth less, and vice versa. If current interest is 4%, it requires TWO 2% bonds to earn the same income. Meaning then no one will pay full value for the lower earning bond. But a short time remaining until maturity (that time is called Duration) limits this effect. Meaning directly held bonds will pay full face value when redeemed at maturity or recall (unless they default with no payment).
Bond funds receive their bond's fixed dividends, which gain increases the funds value. And current interest rates affect the value of their bonds. This affects the price of their shares which affects their customer accounts, which price and shares are then used for the fund dividend in the same way as stocks, i.e., the bond fund dividend reduces the bond funds share price (because the money is removed from the fund).
You might figure that since you pay tax on the dividend, you might as well keep it (esp in retirement when withdrawing anyway), but the stock account does go down then. Retirement might make that withdrawal an acceptable choice, since any kind of withdrawal reduces the principle. Or 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.
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.
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