Buying a dividend
Purchasing a stock or fund just to get the dividend? Put this on the list of "great strategies for people who like paying taxes."
POINTS TO KNOW
- When a dividend is paid, the share value of the stock or fund drops by the amount of the dividend.
- Because the dividend is income, you'll owe taxes on that amount (if you invest in a taxable account).
Think about dividends before investing a large amount
Dividends are announced several days or weeks before they're paid. It could seem like a good idea to buy shares of a stock or fund just in time to get the dividend payment—but in many cases, it's not.
If you're investing through a tax-deferred account, dividends won't impact your tax situation. But if you're investing through a taxable account, these dividend payments will lead to additional taxes for you.
Do the math
Imagine you're interested in buying shares of an investment currently trading at $50 a share. The investment is about to pay a $2-per-share dividend.
Let's say you buy 100 shares for $5,000. On the day the dividend is paid, the market value of each share drops to $48, leaving your share value at $4,800. But you've earned $200 in dividends, which means you're even. So far, so good?
Unfortunately, you now owe taxes on your $200 dividend payment—not so good after all.
If you're investing a large amount, it's a good idea to find out if any dividends are coming up. If so, consider investing your money once that date has passed.
This is one of the only situations when it might make sense to "time" your investment, and it only applies to large sums of money. If you regularly invest smaller amounts, don't interrupt your usual plan just to avoid a dividend.
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How investments are taxed
The distribution of the interest or income produced by a fund's holdings to its shareholders, or a payment of cash or stock from a company's earnings to each stockholder.
Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.
You won't pay any income taxes on the amount your account earns until you take the money out. (Note that with Roth accounts, assuming you meet all requirements, the earnings become tax-free at that time.)
Accounts that don't receive special tax treatment, so all interest, dividends, and capital gains are subject to taxation in the year they're received.