When you invest in a stock, you become a part-owner of that company. So, if you were to buy a few shares in Apple ($AAPL), you would technically own an infinitesimally small part of the largest publicly traded technology company. Congratulations, you fancy business owner, you!
This ownership entitles you a little bit of the company’s profits or cash on hand — if they let you, that is. This small amount of money given to shareholders is called a dividend, and it’s pretty sweet. Not every stock pays a dividend, as they don’t have to. Stocks that do pay a dividend often don’t pay one on any set schedule. When you do receive a dividend, you could receive anything from a few cents to a few bucks for every share you own.
What do you do with this magical money? You could withdraw it and spend it with reckless abandon, but that defeats the purpose of investing. Instead, we have a few ideas on how to use your dividends as a smart investor.
Automatically reinvest your dividends.
Enrolling in a dividend reinvestment plan — also known as a DRIP (seriously) — lets you automatically reinvest those dividends in a stock. If you receive enough dividends to pay for another share of stock, a DRIP automatically takes your dividends and just buys another share (or shares) of stock. You can also choose to reinvest some or all of your dividends. Sometimes, companies even let investors buy new shares at a discount with their dividends, too.
Invest your dividends elsewhere.
Let’s say you can’t invest in a DRIP (as some brokers don’t support them). When you receive a dividend, you simply have it credited as cash to your investment account. Again, you could definitely send this cash to your bank account and spend it, but that would be silly. Instead, consider using this money to invest in more of the same stocks, or other stocks. After all, it’s already in your investment account. Why not spread it around the stock market a bit?
Do anything but spend your dividends. Seriously.
Put your dividends in a savings account or a CD. Put them in your IRA or 401k to get closer to maxing out your yearly contributions. Use them to make a donation that you can write off on your taxes. Whatever you do, don’t spend them. This is almost-free money that you’re receiving from a sound investment. Why not use it to make another sound investment?
There are some things you should know about dividends.
If you receive a dividend from a stock, you’ll most certainly have to pay taxes on that dividend. This is true even if you automatically reinvest your dividends or manually buy other stocks with them. Depending on the type of dividend — as there are a few different variations — you’ll either end up paying capital gains taxes on them or counting them as part of your yearly income.
Be sure to do your research on stocks before and after you invest in them to learn about how they deal out dividends, as each company is different. You should also consult your tax professional about how you’ll pay Uncle Sam for receiving dividends.