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That quote right there is from none other than John D. Rockefeller, American industrialist, tycoon, and, apparently, the namesake of Tina Fey/Alec Baldwin star-making sitcom 30 Rock. Dividends are the bread and butter of any early retiree. You know all that stuff we write about living off passive income? This is what we’re talking about. New readers, please click here to start from the beginning.
How Dividends Work
So how do dividends work? Basically, when a company makes money, they have a few options of what to do with that money (after paying employee salaries). Namely:
- Re-invest in the company (by buying more equipment or hiring more people)
- Sit on the cash and do nothing
- Distribute it to its shareholders
But wait, why would they give it to shareholders when they could do #1 or #2? Well, first of all, sometimes there isn’t a great opportunity to reinvest it (for example, no physical place to put new equipment), or they’re making SO much money they can’t spend it fast enough (I’m looking at you, Coca-Cola!)
Second of all, a company sitting on a lot of cash is a bad idea. This is me getting into Gordon-Gecko-Wall-Street-Trader mode, but basically companies with a large cash balance are vulnerable to a hedge fund swooping in and buying the company out. This is called a hostile takeover, or a leveraged buy-out. If you were a corporate raider, you would LOVE companies holding a ton of cash. Why? Because you could convince some bank to lend you lots of money, buy the company, fire everyone, take the cash (and any hard assets like real estate, equipment, etc.) to pay off the loan, and then run off cackling as the company burns to the ground.
So in a strange twist, having a healthy cash balance is great for personal finance, and a terrible idea for corporate finance.
BUT, the CEOs and executives of a company are usually significant shareholders themselves. So by distributing cash as a dividend, a CEO can reward himself by transferring money from the company into his personal bank account. At which point it then becomes converted into cocaine.
So that’s why companies pay dividends. And this also applies when you own a broadly diversified Index-tracking ETF like the ones we own. Remember, when you own an Index ETF, you are owning shares of all the underlying companies themselves. So when they pay a dividend, it goes to the ETF, who then turns around and divides it among its shareholders.
Now a few important things to know when evaluating an ETF’s dividend yield:
Projected Yield
Calculating a fund’s dividend yield can get confusing. This is because each stock’s dividend is decided on by that company’s board of directors like “Company ABC will pay $0.08 a share every quarter.” In other words, dividends are declared as a certain amount paid per unit.
A stock’s dividend yield is defined as:
Annual payout/ stock price
So, for example if stock ABC’s price is $6 a share and dividend payout is $0.08 x 4 = $0.32.
Then the dividend yield is $.32 / $6 = 5.33%.
But in case you didn’t notice, a stock’s price can change quite a bit. That’s why there are confusing yield numbers listed on an ETF’s summary page that can differ by a lot. For example, at the time of this writing, the EAFE ETF run by iShares has a trailing 12-month yield of 1.62%, and a project distribution yield of 3.24%.
So what gives? The answer lies in the definition of each metric.
The 12m Trailing Yield is: “The yield an investor would have received if they had held the fund over the last twelve months (assuming the most recent NAV).” NAV means Net Asset Value, or the price of ETF share.
If the price of the ETF went up over the last year, it’s 12m trailing yield would get hammered. This is because the money paid during the year is being compared to its new, higher price. And sure enough, XEF went up last year.
So what you want to look for is the current yield projected forward at current prices. This is because your personal yield is determined at the time of your buy.
If you buy an ETF yielding 5.33% and its yield collapses to 4% because the price went up, that only affects new people buying the fund. Your yield was locked in when you bought, and assuming the underlying companies don’t drop their dividends, you get paid the same dividend.
So using the example above, if you bought the ABC stock at $6, with a yearly dividend payout of $0.32, your personal yield is 5.33%. If the stock were to go up to $8, you would still get paid $0.32, even though the yield for new buyers is now only 4%.
So the important metric for you is the Projected Yield. In the US this is called the SEC yield.
Ex-Dividend Date
Another important date to look out for is the Ex-Dividend date of your ETF. This can be found by going to the Dividend Calendar of your particular fund (we showed you how to do this in a previous article). In that calendar, you can see each fund’s Ex-Dividend date.
So what is an Ex-Dividend date?
You must be in possession of this fund on this date to be eligible for its dividend payment. And by “in possession,” I mean you’ve bought the ETF and the trade has settled. Here’s the dividend calendar for the Vanguard Bond Index, BND.
So the last dividend payment is defined by: the Record date and the Ex-Dividend Date. The one you care about is the Ex-Dividend date. As long as you are in possession of that fund on 12/29/2016, you will get its dividend.
The Record Date is the date you have to “register” your ownership of that fund, but that happens automatically when you buy your ETF through a brokerage account, so for all intents and purposes, the Ex-Dividend date is the only date you need to care about.
And DON’T think you can just buy the ETF the day before the Ex-Dividend Date, collect the dividend, and then sell the day after. People have already thought of that. Here’s what really happens. In the absence of news that moves the ETF’s price, the price of an ETF will tend to rise by its dividend amount coming up to the Ex-Dividend Date. This is because owners of the ETF are not willing to sell right before collecting their dividend unless they get compensated for it.
Free market, bitches!
Payout Date
Once your rightfully-deserved dividend is recorded on the Ex-Dividend date, there is often a delay until you actually receive your check. The day you actually get your money is recorded as the Payout Date, named after, unsurprisingly, the date that you get paid out.
The day after is also recorded as “Cocaine Day,” but we won’t talk about that too much in this article.
That’s All Folks!
And that is it for this week. See you all next Wednesday. Peace out, yo!
Continue onto the next article!
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Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.
Great article Wanderer; I think i’ve read everything you guys have written and I’m loving being part of this community.
A few questions; Since we are DCA’ing, we would then have different amounts of the purchased ETF Stock/ Bonds with different ex-Dividend dates? So each 2 week purchase would mean we would have a different dividend amount based on the new purchase?
Who’s sends a cheque? Questrade?
Can we request the dividend to be deposited into our cash account on Questrade?
Aww, thanks. That means a lot to us.
And the Ex-Dividend dates are determined by the ETF manager. So if an ETF decides they will distribute dividends on the 1st of every month, as long as you own that ETF on that day, you will get your dividend equal to however many cents per share times the number of shares you own.
And the money gets deposited into your trading account at Questrade. You can then decide to reinvest it if you want.
Thanks again for another very practically useful article. What about automatic reinvestment (DRIP)? Do you guys recommend that?
DRIPs are fine, but since we’re DCA-ing, any dividends you get will automatically get swept into the next round of cash buys, so we’re effectively implementing a DRIP.
One comment to add is that most trades take a few days to settle and afaik, your trade has to have *settled* by the ex-dividend date in order to collect the dividend.
Great point. I’ll add that to the post. Thank you!
If dividends = cocain, then that explains a lot about why it brought Rockefeller pleasure.
Enlightening post!
That is true. If he had been more honest he would have cut out the middleman and just said “Do you know the only thing that gives me pleasure? It’s to see my cocaine come in.”
Now that is a message I think we can all get behind.
Thanks for your thorough analysis! Very helpful!
In Canada, individuals can receive approximately $50K in dividends without paying any federal tax (and provincial tax, in many cases). Obviously this is irrelevant if the stocks are held in an RRSP or TFSA. Thus, a stock that pays a 4% dividend is, depending on your income level and province of residence, roughly equivalent to a bond that pays 6-7% interest.
The other nice thing about dividends is many stocks have a dividend reinvestment program (“DRIP”). Instead of receiving cash, you receive additional shares in the company (you can’t have fractional shares, so it’s usually a combination of shares and cash). This is beneficial because you’re automatically increasing your position in the stock without any transaction costs. Some stocks even offer a discount from market value for DRIPs (this has become less common in recent years – but some of the banks offer 2% discounts, and some smaller stocks on the TSX offer up to 5%).
Excellent point. This is my first full calendar year in retirement and I realized when I did my taxes that my total tax payable will be $0 precisely because of that dividend tax credit.
I’m starting to see the wisdom of Rockefeller’s words. Now where do I go to get me some cocaine?
NOTE TO RCMP: That was a joke. I am not going to buy any cocaine.
…Or am I?
No. Definitely not.
Well…probably not.
Ahem. Let’s move on.
I’ve been reading every single one of your articles diligently since discovering your blog 3 months ago. I genuinely feel like I’ve learned a lifetime of knowledge and the way I think about personal finance is completely changed. I’ve wanted to follow the workshop but have a slightly complicated situation of being a Canadian living in Australia (where I will probably stay until I retire because screw ever having to defrost a windshield ever again). I’m just wondering, as expats yourselves having retired, do you still keep all your investments with Canadian brokerage? Or have you used international brokers such as TD Direct Investing International? It seems like the TD International account has a lot of benefits for people who lead a nomadic life such as managing multiple currencies and possible tax benefits for being based in Luxembourg. If you have any experiences or opinions on this can you share?
Awww, thanks! Hearing that someone learned something from my crazy ramblings means a LOT. Thank you.
Generally, we keep our investments where we worked. Where we travel (ie spend), we put on credit cards where we then pay off with our accounts back home.
But knowing that you’re Canadians living in Australia, we have just one advice: MAX OUT YOUR SUPERANNUATION ACCOUNTS!!! The supers have all the benefits of our RRSP/401Ks, as well as our TFSA/Roth IRAs. The critical problem with them is that as an Australian citizen you can’t touch them until you’re in your 60’s, but as a non-resident you can get access to them tax-free once you leave. So make sure you max them out!
Haha no thank you and FIREcracker. Honestly, I didn’t have the slightest idea about investment and personal finance before I started reading this blog. I always had in my mind what my tiger mom told me and still tells me – buying a house is the single most important thing you need to achieve as an adult. I also thought investments and the stock market was all about picking that magical stock that eventually becomes the next Apple and was going to trust a financial advisor at my bank to invest my money. I had no idea how easy it was as a layman to understand the markets. You have completely changed my worldview and actually made me interested in managing my own money. As a fellow millennial thank you and kudos to you guys for going against the grain and forging your own path.
Travelling has always been my and my partner’s lifelong passion as well. I quit my soul sucking advertising job in Canada to travel Asia-Pacific for as long as I could and everyone thought I was crazy. I met my partner backpacking and ended up settling in Australia where we are based now. Ultimately our goal is to keep travelling and the idea of having FI and basing yourself wherever you want in the world like you currently are doing would be our dream come true. We have a long way to go but thanks to you guys we have a genuine drive now and are working to learn as much as possible as the first step.
hi Wanderer, I am a Canadian living in US. WE can’t not do any investment in Canada as we are non-resident now. We still have some money idle sitting in the bank. Not sure how we can use it the best way. with current low exchange rate, it seems not worth it to exchange it to USD. Any advice?
Hi guys,
With FIRE in mind, isn’t it better to select ETF’s where they pay out the dividend in cash? In the beginning phase, you can simply reinvest them yourself. When FIRE is about the start, these pay-outs can be used to support your lifestyle, resulting in withdrawing less money by selling stocks. (I am aware that this is not the most tax efficient way to do it in the States or Canada, but living in Germany, the law is slightly different). Starting 2018, you’ll be taxed on the yield, even when you select an ETF where the dividend is automatically reinvested.
This is a great course; thank you so much for making it available for free! I’m trying to follow it but I’ve run into a few problems:
1. I already had an account at Questrade, and I own some stocks. Not sure if I should sell them and buy these ETFs, or just wait. I was trying to buy mostly monthly dividend stocks. I like this whole “dividend” thing.
2. I think I did the margin thing by accident. I have a negative cash balance of US funds for some reason in my Questrade account. What does it mean? It doesn’t seem to make a difference.
3. I had heard that an easy way to invest in the stock market before was VBAL and VGRO ETFs, so now I own VBAL stock. Is your way better? Why?
4. Similar to the above, I see Vanguard is now offering VEQT–an all-equity portfolio. Go big or go home, I say, so that appeals to me. But it seems very new and I’m not sure about it. Thoughts?
5. I think I fell victim to a pump-and-dump with NXO.VN stocks. They’re up 40 cents now though…lol. Luckily that little experiment only cost me about $10.
6. WHY DON’T THEY TEACH THIS IN SCHOOL!?!?!?!? Sorry for shouting. Also, I know why. *sigh* But I am 40 and I have literally been trying to figure out how the stock market worked and how to invest in it for 20 years. I’ve wasted so much time. 🙁
I’m a little late to the party but wow—thank you! I just finished your book & honestly you answered so many questions for me. I’m grateful. On this post, is this part right:
“As long as you are in possession of that fund on 12/29/2016, you will get its dividend.“
Should it be 12/22 or am I looking at this wrong? THANK YOU!