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WalletPrep worksheet · Investing

What are dividends and how do they work?

Name ____________________ Date __________

Key ideas

  1. Dividend yield is yearly dividends divided by price. Lena's fund pays $0.40 a share each quarter, $1.60 a year, on an $80 price. That is a 2% yield.
  2. A company can cut its dividend anytime. Companies often cut or stop dividends when business is bad. A yield far above similar companies can be a warning sign.
  3. Taxable accounts tax dividends every year. You owe tax the year you get them, even if reinvested. Inside a 401(k) or IRA there is no yearly tax.

Vocabulary

Dividend
A payment a company makes to its shareholders out of its profits, usually in cash and often every 3 months.
Brokerage account
An investment account where you can buy and sell stocks, bonds, ETFs and mutual funds. It has no special tax benefits.
Stock
A small piece of ownership in a company. Its price rises and falls with how investors value the business.
Index fund
A mutual fund or ETF that tries to match a market index by holding the investments in it, rather than picking winners.
ETF
Exchange-traded fund: a basket of investments that trades on a stock exchange throughout the day, like a single stock.
Ex-dividend date
The date from which a new buyer of a stock no longer gets its next dividend. You must own the shares before this date to be paid.

Work it out

Lena owns 50 shares of a stock index fund priced at $80, worth $4,000 in her brokerage account. The fund pays $0.40 a share every quarter.

  1. Shares owned
  2. Dividend per share, each quarter
  3. Quarter 1
  4. Quarter 2
  5. Quarter 3
  6. Quarter 4
  7. Dividends for the year
  8. Dividend yield ($80 ÷ $4,000)

Check yourself

  1. A fund pays $0.25 a share every quarter and trades at $50. What is its dividend yield?

    • A. 0.5%
    • B. 1%
    • C. 2%
    • D. 25%

  2. You reinvest all your dividends in a regular brokerage account. What happens at tax time?

    • A. You owe tax on them for that year
    • B. Nothing, because you didn't take the cash
    • C. You owe tax only when you retire
    • D. They are tax-free if under $1,000

  3. What usually happens to a share price on the ex-dividend date?

    • A. It rises by the dividend
    • B. It may fall by about the dividend
    • C. It doubles
    • D. Trading stops for a day

Your turn

Log in to your brokerage or IRA and find the dividend setting. If you are saving for the long term, switch it to reinvest for every holding. Then look up your fund's dividend yield and note how often it pays.

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Answer key

What are dividends and how do they work?

Work it out

  1. Shares owned50
  2. Dividend per share, each quarter$0.40
  3. Quarter 1$20
  4. Quarter 2$20
  5. Quarter 3$20
  6. Quarter 4$20
  7. Dividends for the year= $80
  8. Dividend yield ($80 ÷ $4,000)2%
  1. Each quarter she gets 50 × $0.40 = $20. Over four quarters that is $20 × 4 = $80.
  2. Her yield is $80 ÷ $4,000 = 2%. If she reinvests, each $20 payment buys $20 ÷ $80 = 0.25 more shares at today's price.
  3. If all $80 is qualified and her rate is 15%, she owes $80 × 15% = $12 in tax, even if reinvested. In an IRA she would owe nothing that year.

Check yourself

  1. C. 2% Yearly dividends are $0.25 × 4 = $1.00. Yield is $1.00 ÷ $50 = 2%.
  2. A. You owe tax on them for that year In a taxable account, dividends are taxed in the year you receive them, whether you take the cash or reinvest it.
  3. B. It may fall by about the dividend The cash paid out is leaving the company, so the price may fall by about the dividend amount on the ex-dividend date.