Dividends can be one of the most valuable ways for investors to earn a passive income. It’s a simple way to get a sum of money paid regularly as a reward for investing in a company.
Below we unravel how dividends work and introduce a Dividend Tracker that will help you stay on track of your dividend income. It’s the perfect tool to summarise and forecast your dividends!
What Is a Dividend?
A dividend is the distribution of a company’s profits or reserves to its shareholders. The sum of money paid to each investor depends on the number of shares they own and the dividend per share chosen by the company.
For example, if company A decides to pay $1 of dividend per share and you own 100 shares, you will receive $100 in dividends.
What is Dividend Yield?
As dividends vary per company, it is important to understand the dividend’s return based on the investment. Company A’s $1 dividend per share might seem higher than Company B’s 50-cent dividend per share. However, by computing the dividend yield you can understand which share will provide a higher dividend return to investors.
The Dividend Yield is :
To calculate the dividend yield all you must do is divide the annual dividend per share by the current price per share, multiplied by 100 to get a percentage.
|Company A||Company B|
|Dividend per Share||$1||$0.5|
|Current Share Price||$100||$25|
Company B’s dividend per share might seem low, but when you look at the dividend yield it is evident that they are providing a higher dividend return than Company A. Nevertheless, the dividend yield is only an estimate of the dividend return. Dividends and share prices regularly move up and down, therefore, this yield fluctuates endlessly.
Dividend Reinvestment Plan
Investors can set up a dividend reinvestment plan (DRIP or DRP) to reinvest their dividends automatically. This method uses the dividend received to automatically purchase more shares. It’s a win-win situation: as more shares are acquired, more dividends are received, and you benefit from compounding. This of course is assuming the dividends are stable and are not cut off.
Suppose you own $5,000 worth of Company A’s stock. It has a dividend yield of 1% when the share price is $100. Therefore, the total dividends received would be the shares you own (50) multiplied by the dividend per share ($1); = $50.
When dividends are paid out, the company’s share price is reduced to the value after payment. In this case, the new share price after the dividend payment would be $99 per share.
If you have a DRIP set-up you would purchase 0.50 ($50/$99) shares making you have a total of 50.50 shares. Assuming there is no change, the following year you would have $5,050 worth of stock. This cycle is repeated and your investment continuously grows.
Check out this graph by Hartford Funds in their dividend reinvestment analysis of the S&P 500:
“Going back to 1970, 84% of the total return of the S&P 500 Index can be attributed to reinvested dividends and the power of compounding”Hartford Funds
Taxes and Franking Credits on Dividends
Whether you get a cash dividend or have DRIP set up, all dividends count as income and must be declared for tax purposes. Fortunately, the tax bill can be shrunk through tax deductions or tax refunds by using the franking credits system.
Franking credits are essentially a system where double taxation is considered given that companies already pay tax on their earnings that are subsequently distributed through dividends. Make sure to read more about its benefits in this in-depth analysis.
To solve all the intricacies of dividend performance and record-keeping for tax season we introduce the Dividend Tracker.
This Dividend Tracker analyses your investment portfolio and dividend transactions to show a breakdown of your dividend income per month and year. There’s a function that calculates your payable tax by entering your expected income tax rate and a section that forecasts your dividends based on historical patterns.
Check out this video explaining step by step how to use it:
Dividend Tracker: Prophet’s Take
Dividends are a strong pillar of the investing world. They provide valuable benefits to investors wanting to earn a passive income and act as a powerful engine to compounding when reinvested.
Multiple dividend distributions, taxes, and franking credits create a record-keeping nightmare for investors. Therefore, we hope this dividend tracker helps you get back on track to analyze performance and ultimately make better financial decisions.