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Help! I can’t understand if I’ve made any money with my dividend-paying investments!

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Having difficulty understanding if you’ve made money with a dividend-paying investment?

So many investors look at their statement when it arrives and think:

I haven’t made any money! (Cue gnashing of teeth.)

But is it true?

Let’s say you hold investments that are of a dividend-paying nature. How do they operate?

Well, whether you’re investment is a mutual fund, an ETF or a stock, if it pays dividends, and you don’t really understand how dividends work, you’ll be confused.

Paid to wait

First, it’s important to separate your original investment from your dividend payments (distributions).

Dividend payments might be:

  • Monthly
  • Quarterly

or,

  • Yearly

Most dividends come in quarterly payments.

In this example, I’m going to use Royal Bank, a widely-held Canadian bank stock. It doesn’t matter what dividend-payer you use. It’s also the same with an ETF, a stock or a mutual fund. It’s only the terminology that changes (e.g. shareholder or unitholder).

Royal Bank pays a dividend of .63 cents quarterly. If you hold 100 shares of Royal Bank, you’ll receive a payment of approximately .63 cents four times per year per share.

Why “approximately”? Because depending on the health of the company, it may raise or lower the dividend. For example, Royal Bank raised it’s dividend payments this year. It’s first two dividend payments were .60 cents, and the last two were .63 cents.

To make things easy, let’s assume Royal Bank had made four dividend payments of .63 cents:

4 x .63 = 2.52

In my example, the dividend payment would be $2.52 per year. If the stock were valued at $62.00, that yearly dividend payment would be equal to 4.06 per cent (or one year’s dividend payments). Our example is very close to Royal Bank’s dividend yield (currently 3.94 per cent).

Let’s imagine the Royal Bank illustration above was a mutual fund. If the fund paid a dividend of $2.52, the dividend payment amount would be subtracted from the unit price each quarter.

Each time the dividend was paid (.63 cents), the unit price of the fund would be subtracted by the dividend payment.

Why?

But wait! Wasn’t there a dividend payment?

Because your Adjusted Cost Base (ACB) changes when dividends are paid out.  If the unit price of the fund did nothing, for example, ended the year at the same price it began it, your investment would look like it hadn’t made any money. Superficially, at least.

But it would have, because, when you receive the dividend, you get more shares / units. Your 100 original shares will increase in number.

Didn’t that fund pay $2.52 for the year? And wasn’t that payment supposed to be 4.06 per cent? And so, didn’t you, as an investor, make over 4 per cent on your investment?

Yes.

And every time the dividend was paid out, didn’t you get additional shares in your investment?

Yes.

But the four dividend payments, when made, count as dividend income if they’re held outside of a registered account. The dividend is reinvested into the fund. So, when your payment of .63 cents per share is made, for accounting purposes, it’s considered new money and a new investment.

In a future post, I’ll give you an example of what this looks like, and a key error less-experienced investors make in understanding their investments.

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This work and all work on this blog is licensed under a Creative Commons Attribution-ShareAlike 3.0 Unported License.

Image: Flickr, Daily Dividend.

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Written by johnrondina

August 27, 2013 at 5:35 pm

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