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How Dividends Play Out - and How the Market Knows It

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Let's say you own a dividend-paying stock, and you want to sell it, but you know that normally the stock pays a dividend before the end of the year. Should you wait until the dividend is paid before selling?

The logic for waiting to sell a stock until after the dividend is paid works like this: Stock ABC is worth $25 per share. It is going to pay a $1 dividend. I would like to wait so that I get the extra $1 before selling. Except dividend-paying stocks do not work like that: As soon as the dividend is paid—all else being equal—the stock price goes down by the dividend amount per share. The reality is: ABC stock was worth $25 per share, then it paid out cash from their assets equal to a $1 dividend, now it is worth $24 a share. The end results are the same:

  • Sell ABC stock before the dividend was paid: ABC at $25 + 0 dividend = $25.
  • Sell ABC stock after the dividend was paid: ABC stock at $24 + $1 dividend = $25.

The same logic applies to rolling over your 401(k) before or after dividends are paid. Your total balance will generally be unaffected by the paying out of dividends.

An example:

Your 401(k) has multiple holdings worth $500,000. Dividends of $5,000 are paid. Your 401(k) holdings are automatically individually rebalanced with the $5,000 worth of dividends to still equal $500,000. The dividends did not increase the balance of your 401(k).

It is true that speculation and other factors related to dividends can affect a stock’s share price; but generally speaking the direct net effects of dividends on total return are nil. However, the re-investing and compounding of dividends have huge effect on portfolio returns.

Some important vocabulary to note: 

Declaration date: The day a company announces a dividend, how much the dividend will be, when it will be paid, the Date of Record and the Ex-dividend date

Ex-dividend date: The day when the stock trades without the dividend value. It occurs one business day before Date of Record. If you buy the stock on or after the ex-dividend date you will not be paid the dividend.

Date of Record: The day on which the company says you must own the stock in order to get paid the dividend. This is one business day after the ex-dividend day.

Payment date: The day the stockholder will receive the dividend if they have owned the stock on the date of record. If you sell the stock after the ex-dividend date, but before the payment date, you will still get paid the dividend; and conversely, the new owner of the stock will not get paid the dividend.

An example using all the terms

You own shares of ABC company. ABC company on November 1st (Declaration Date) says the dividend for ABC stock will be $1 per share, paid on December 22nd (Payment Date) to all shareholders as of November 24th (the Date of Record). The Ex-dividend date will be November 23rd, one business day before the Date of Record. If you sell ABC stock on or after November 23rd, you will be paid the dividend. Whoever buys your ABC stock on or after November 23rd will not get the dividend, making the shares less valuable on that date — by the amount of dividend per share.