What Are Homemade Dividends?
Let me explain homemade dividends to you directly: they're a type of investment income you generate yourself by selling off a portion of your investment portfolio. This is different from the traditional dividends that a company's board of directors decides to distribute to specific classes of shareholders.
Key Takeaways
You should know that homemade dividends represent investment income from partially selling your portfolio. They're not the same as traditional dividends issued by a company's board to shareholders. The fact that you can create these homemade dividends has led to debates about whether traditional dividends really provide substantial value.
Understanding Homemade Dividends
As an investor, your ability to create homemade dividends raises questions about the true value of traditional dividends. Some experts argue that since a stock's price drops by exactly the dividend amount on the ex-dividend date, it cancels out any gains.
This concept is central to the dividend irrelevance theory, which states that you don't need to worry about a company's dividend policy because you can always sell parts of your equity portfolio if you need cash. Critics of this theory point out that selling shares leaves you with fewer shares overall, reducing your asset base even if you get short-term cash.
Fast Fact
Economists Merton Miller and Franco Modigliani were pioneers in arguing the irrelevance of corporate dividends, publishing their theories in the early 1960s.
Traditional Dividends
A company's board of directors is responsible for declaring dividend payouts to shareholders. After the declaration, they set a record date to identify eligible shareholders. The ex-dividend date, two business days before the record date, is the last day a seller can still claim the dividend even after selling the shares.
Regular dividends usually happen monthly or quarterly, while special dividends are one-time payments. Boards often declare special dividends after strong earnings or to restructure finances or spin off subsidiaries.
Companies in sectors like basic materials, oil and gas, financials, healthcare, pharmaceuticals, and utilities typically offer the highest dividend yields. Also, master limited partnerships (MLPs) and real estate investment trusts (REITs) are known for high dividends because they're mature with stable cash flows.
On the other hand, startups and high-growth companies, especially in tech, rarely pay high dividends. They prefer to reinvest earnings into research, development, or expanding operations.
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