Most people understand “interest” from savings accounts and CD’s. But few truly understand dividends, how they work, and the benefits long-term. So let’s try to explain.
Simply speaking dividends are payments from corporations to their shareholders (investors of the company). Prior to each dividend, the board of directors declares the amount to be paid to shareholders. Dividends are usually paid quarterly and can be distributed in cash or reinvested to accumulate additional shares. Today you may find companies or stock mutual funds that pay reasonable dividends in the range of 2% to 4% each year.
Many investors prefer stocks or mutual funds that pay reasonable and predictable dividends. These dividends can supply a stream of income compensating the investor with some form of return, while they wait for a potential longer-term overall return.
Stocks that pay dividends can generally be less volatile than companies that pay no dividends. One reason for this is that the investor is compensated for their investment risks each quarter, through the dividend, rather than waiting long-term to receive any potential benefits of growth. Keep in mind this is a general principle and is not always the case for all stocks and mutual funds. Also, savings accounts and CD’s are typically guaranteed (FDIC insured) and stocks are not. This means that the investor can see fluctuations in the value of their stocks or mutual funds. Remember, past performance doesn’t guarantee future investment returns. That said, also remember that dividends can provide some benefit in the meantime while investors wait for longer-term potential growth.