Dividends are a Forced Withdrawal,
NOT new income.
NOT reinvesting dividends
is a poor investment plan

If you might think of stock and fund dividends as being a new free gift of additional money, then you really should read the following explanation about how that IS FAR FROM TRUE. Withdrawing dividends is very COUNTERPRODUCTIVE to long term gains. The Big Deal is that it is stock DIVIDEND REINVESTMENT that is extremely important instead.

So a dividend causes absolutely no value change to you on that distribution day, except the dividend money is back in your pocket instead of being still invested and your stock price is that much lower now. And you do owe some tax on that withdrawn part now too. But your investment value is left reduced at every withdrawn dividend. Stock prices of course go up and down every day, so the dividend reduction might not be noticeable, but you will certainly believe it if the stock pays a large dividend, like 6% or 8% once a year.

However reinvested dividends definitely can have considerable long term value, because if reinvested to put it back, it becomes additional free shares (free of any additional cost), which will increase future gains over the years, which is a quite huge effect long term. No additional cost means you already owned the dividend money, and refused the withdrawal, and put it back to still be invested. It was to have been just a withdrawal, NOT new income. My goal is to make a believer of you about this, so you won't waste future earnings by withdrawing the dividend.

Again, if you instead put the money back by reinvesting the dividend, it returns the dollars of investment. It also provides a few additional free shares, usually every quarter, which compensates for the price drop. There is still no gain on that first day, it is just back to even again. However the earnings of additional shares every quarter are a mighty Big Deal to increase future earnings, year after year. And it is certainly a good thing to know.

Reinvesting Stock or Fund dividends (instead of any withdrawals) are very healthy for a growing investment. A few decades of growth will be all-important to retirement (so start young to avoid missing out on the years of compounding). The detail is below, but stock dividends are costly withdrawals, because it leaves less money to grow. You can easily put it back though, and then gains on reinvested dividends are compounded and keeps earning more future gains, continually. Any frequent withdrawal (of stock dividends or otherwise) can very seriously reduce future compounded gain earnings.

Some companies regularly distribute some of their gains to stock holders. Others don't (primarily the growth stocks don"t, at least in their early years), and instead reinvest their gains into building their company and increasing their stock value.

First Things First:   The Cost of Withdrawals

See this calculated loss in a S&P 500 chart on the S&P calculator page, calculating the actual cost of withdrawing dividends from a S&P 500 Index fund. It computes past S&P history of $25,000 invested for up to 50 of the past years. The S&P 500 dividend for the past 50 years has averaged around 2.8% a year, and is about 1.7% currently. That may sound small and insignificant, but the years of compounding definitely is a huge advantage. However, withdrawing it becomes unimaginably costly over the years.

This loss is a long term thing, not so much in only a year or two, but withdrawing dividends can cost about 25% of the overall investment value after 25 years, and maybe 40% after 35 years, and about 60% of it after 45 years.

It seems obvious that the best retirement planning is to start a good investment as early as possible, and let it grow for as many years as possible, until the retirement time comes to start withdrawing it. The many years of compounding is the major part of the gains.

This article is about stock and fund dividends, including bond funds (but directly held bonds are different than stocks or funds). Resell value of bonds are affected by current interest rate changes for the new bonds, however it changes the value of existing bonds. But bonds that are purchased directly and held until maturity or until recalled are then redeemed at full face value, without value change. You should be very aware of the difference of buying bonds directly vs. bond funds. Directly held US government bonds can be purchased directly from the US treasury, and possibly through your own broker. But bonds held in a bond fund are a fund, not directly held. Any bonds that are sold prior to redemption do vary in price due to interest rate changes (because if interest rates have increased, the buyer also has other better options then). Bond dividends in funds could be reinvested to provide compounding, but the value of bonds in a fund are priced according to current interest rates. But yes, directly held bond dividends are income (but stock and fund dividends are mostly taxed as capital gains after the first year).

But stock and fund dividends when paid do automatically equally reduce a stocks price value remaining (because the company's value decreases when they pay out dividends — more below). Withdrawing stock dividends are the same as any other withdrawal, simply lowering the overall value remaining. However, stock dividends can be reinvested to retain the same investment value, and then, the additional shares will increase compounding of future earnings, which then becomes significant income long term.

My purpose here is to emphasize that it's a seriously costly mistake to think of stock or fund dividends as New income to be withdrawn. The dividend is just a withdrawal of previous gains, which reduces your fund's value and its future gain potential. The withdrawal changes Unrealized Gain to be Realized Gain which is then taxed as income, but it NOT new income. Withdrawal makes it be Realized income (moving it into cash in your hand). I suspect many people interested in dividends have not thought about how it works and the effect of it. If you might be withdrawing stock or fund dividends, I hope you will rethink it. The dividend is certainly Not a gift to you, it is a distribution, simply a withdrawal from your own stock investment into your withdrawn cash (Realized Gain). If you are withdrawing when in retirement, then withdrawal was the planned goal, but if your earlier investment is still growing, the reinvestment gain can become huge over the years (or the withdrawal loss also huge).

The stock dividend simply transfers it from your stock into your cash account, which then reduces the stock price equally (same dollars per share as the dividend), so the smaller remaining investment in the stock has less value now, but you do have the cash difference. So there is no gain or loss, yet. Imagining the dividend is a gift of new income to be withdrawn is very wrong, it is simply a withdrawal from your stock, which equally reduces the value of your remaining investment. If you want to maintain the prior invested value, you can put it back by reinvesting the dividend. Reinvesting buys more shares, which is also a few more free shares than you had before. Then the current and prior total value sums are the same (no change in value on that day), but future gains do have more shares working after each reinvested dividend, which is a pretty big deal. This reinvestment purchase is added to your cost basis, so you don't pay tax twice on the dividend.

A stock's dividend does not pay a fixed rate (not some % a year, not like bonds). The company simply decides how much profit dollars (if any) they will distribute to the owners, so they decide and declare some amount of dollars per share to distribute. Investors then may like to compare that as a percentage of stock price, but the stock price varies every day, so the dividend percentage varies every day too (but the dollars paid stays fixed). A popular method for the long term is to compute percentage from (the years total dividend dollars) / (the year end stock close price). Some companies pay no dividend, preferring to use the profit cash to fund future growth.

The returned dividend cash withdrawal is now in your direct control, cash which you can either keep or reinvest for additional shares of stock at the lower price, which means a few more shares than before. It is Free additional shares, meaning no additional cost than you already had invested before.. The increased shares and the lower price computes to be exactly the same previous value on that first day. So your account's value change due to that reinvested dividend distribution is still zero difference on that first day. It was just a withdrawal that if it is put back (reinvested), it retains the same value. You do pay tax on that withdrawal (reinvested or not), but then the reinvestment purchase is added to your cost basis so you will not pay tax on that dividend part again.

So what's the point? Reinvested or not, there is no overall value change on that dividend day, but your investment itself decreases when the dividend is withdrawn, but not reinvested. If it is a good investment, then of course, the optimum thing to do is to reinvest that dividend to maintain the investment value, and it will also become additional shares for free, every year. That is future gain offered if you want it, and the Big Deal is that your additional shares (received and reinvested usually four times a year) are now greater future investment gain opportunity. This additional gain is not large for just a year or two, but it becomes huge compounded over the long term years. If dividend is reinvested, then you will have additional shares for the same original investment cost. If each quarterly dividend was say $250, four times is $1000 a year of additional shares invested every year, which is compounded growth. But if that dividend cash is instead withdrawn, it has no future growth possibility, at least not in this stock or fund. It was only a direct withdrawal subtracting from your existing value. Withdrawing the dividend cash is a loss of that opportunity for much greater gain. That cost is relatively small over only a couple of years, but the loss of compounding over a few decades is a major cost of the vast majority of the investment potential. The table above shows that withdrawal cost.

But bottom line is that reinvestment of dividends is free additional shares four times a year which will have a huge impact on decades of future earnings.

There is only this one correct way to view stock dividends. Dividends are subtracted from your own stock value you already owned (from the stock's value). Any withdrawal is just subtracted from the stock or fund value. The dividend withdrawal is taxed then, but it is NOT new gain, it is merely realized gain of cash withdrawal (same as any other withdrawal).

So withdrawing dividends would clearly seem a big long term investment mistake, to be only just a simple direct withdrawal that reduces both your current and future fund value (again, same as any other withdrawal). The dividend percentage might sound small and insignificant, but it is HUGE when reinvested and compounded every year for a few decades. There's a chart on the S&P calculator page showing the devastating huge long term loss of withdrawing dividends in an example with a S&P 500 Index fund. Stock Dividends are valuable because reinvestment offers additional free shares, but withdrawing it is just a withdrawal from the fund, and is NOT new income (free meaning no additional cost than what you already had invested before).

The share price drop of a small dividend may be hard to notice in the numbers, but a large dividend (perhaps 6% or 8% paid only once a year in December, for example, TWCIX or VGHAX), may be called Capital Gain instead of Dividend, but same thing, both are withdrawals which can drop your favorite stock price enough to be very noticeable that day. But that price drop simply means that the dividend was paid. If you reinvest the dividend, your stock or fund will still have the same value, and also a few more shares (if reinvested, then still exactly same value on that day despite the lower price). There is no devious plan doing this, but yes, the price is automatically adjusted down, same as is done in events such as splits. Because the companies value does drop by the paid out dividend, which might be $Billions for the companies, so their remaining value did seriously drop. But you do now also have that dividend, and this is really just market action, since the stock no longer promises to pay the dividend already received by the owners, and new buyers will not bid higher to include it. True of every stock and fund that pays a dividend (and even bond funds paying interest). Any dividend lowers the price that day, so the dividend is Not income on that day. But dividend reinvestment does add a few shares (often four times every year) which certainly increases long term compounding of future gains.

You might think that since you have to pay tax anyway on the dividend paid this year, you might as well withdraw it. That might make some sense during retirement if you are withdrawing living expenses anyway, but dividends are NOT income that day, it is just withdrawn investment already owned. It is simply a withdrawal of fund value then, so the stock or fund drops that much too. But if reinvested, the overall value remains unchanged on that day (more detail below), but in the long run (without withdrawals), it is more shares which can in fact earn more, and the compounding of the additional reinvested shares (often four times a year, every year) will be a real earnings payback in the future.

Stock and fund dividends (including bond funds) are different than direct bond dividends.

• The stock or fund dividend is the same withdrawal as if you had sold that much of the stock.
  Except actually selling stock or fund value reduces the count of shares, but still at same share price.
  But the dividends (dollars per share) reduces stock share price (same dollars per share), but still at same share count.
  Either way, the stock value decreased by the amount of the dividend withdrawn.

  A fund holds stock and/or bonds from many companies or bond sources, so all the dividends are collected into the fund value, and the fund issues their own dividend, of which you get your fund shares proportion of it.
  Either way, a dividend withdrawal reduces price, not shares. If the same dollar value is withdrawn, the resulting total dollar value (sum of remaining invested value plus withdrawn amount) on that first day is still exactly the same previous total sum, but you have it as cash now, no longer invested in the stock or fund value. You can keep the cash, or you can reinvest it. If you reinvest it on that same day, putting it back again restores the previous invested stock or fund value, with the lowered price, but with a few new additional free shares to be the same prior total.

• If you directly hold the bonds, the bond dividend is interest paid on the bond face value, and you get the interest cash. I don't know a way to reinvest it other than to accumulate the cash until you have enough to buy new bonds. Direct holding does mean you have the choice to hold it until maturity redemption, preventing current interest rate increases reducing your bond resell value.

There are about 66 stocks referred to as Aristocrat Stocks, which to be included in their list, the companies must be in the S&P 500 (largest US companies), and must have increased their dividend every year for 25 years, a point of pride indicating a stable business. See that Aristocrat Stocks list. But their annual increases can be small, and about half of them still pay less than 2.5% dividends (per year), and a few of those still pay less than 1%. Their average dividend is about 2.25%, but they do increase somewhat every year. If searching for high dividends, do also check for Total Return % too, because some have negative fund gains.

Summary of Dividend Payment Details

Many probably don't understand market dividends correctly or completely, but they ought to make the effort.

• When a dividend (of X dollars per share) is paid out to you, your stock's price drops by the same X dollars per share. The company is sharing their profit, but they did NOT give you this as a gift. It is instead a distribution withdrawn from the stock you already owned, but you do now have this dividend amount as "realized cash", which is taxable now (same as any withdrawal). So the withdrawal makes your investment value go down, but you did receive that difference in cash, so the total amount (on that day, including the cash received) is still your exact same total sum as before. But which again, is Not New income, you already owned it. The difference is that the transaction exchanged (cashed in) some of your stock value for the cash you received, cash which is now taxed (regardless if you reinvest it or not).
• Also, when a mutual fund sells some of their investments, that "realizes it", so they must report the gain or the loss as a dividend 1099 form to you (it is your gain or loss). The dividend may or may not be called capital gains, but either way, the 1099 does show the detail for your tax purposes.
• In the U.S, you will receive a 1099 tax form, owning tax that year on the portion of the dividend that is gains. It is a very big mistake to think of it as new income, which it is Not, because you already owned it until it was withdrawn and sent to you. You do pay tax now since you withdrew this dividend money (when it becomes "realized gain", meaning you exchanged stock value for the equivalent cash). You will owe tax on the gain portion of the remaining stock only when you sell it, but its price was reduced at the Dividend day, removing the taxable value that was just received as cash. The dividend was simply a withdrawal from your investment.
• If you withdraw the dividend, you just keep the cash, but your stock account (on that first day) goes down by exactly the same amount. There was no new income, it was exactly a withdrawal and you do have the cash difference. But you now have a smaller investment than you originally had, with less future growth. Withdrawing the dividend is the same as any withdrawal.
• If the dividend is reinvested, the purchase buys a few more shares which do become additional future income potential (very possibly a lot of it long term). The new total of all your shares then at the lower price on that first day is exactly the same value as before. There is still no new income on that first day. However the additional shares should then earn more future income, compounding over the future years (and long term, it becomes extremely significant income, so think twice about screwing up your investment. Withdrawing dividends is extremely costly, just not worth it. The income from increased shares earns more future earnings. The cost basis of the original stock is increased by the new purchase, meaning you will not pay tax on the dividend portion again.
• So repeating because it is so important. Withdrawing dividends is simply a withdrawal of money you had already earned, the same as any other withdrawal, which simply reduces the value of the account. Withdrawing the dividend has a drastic long term cost on the future value.

  Reinvesting the dividend puts back its value, keeping the account value the same. There is no dividend income on that day, it was already your money. However the big deal is that reinvesting dividends does buy new additional shares which will increase future gains. Compounded long term, that has a large effect on earning gains.

Near 80% of the S&P 500 companies pay dividends in some degree. See a list of these ranked by dividend (however the dividend is "dollars per share", so the percentage number also depends on current price, which routinely changes a bit every day). If interested in high dividends, you should also check out the performance of that ticker too, high dividend does not mean high performance. The S&P 500 index funds distribute that S&P 500 dividend proportionately into your fund shares. You might not even realize you are getting a dividend, but if reinvestment is not already set up, it should appear in your account in your brokers settlement money market fund. That would be withdrawals that reduce your stock investment value.

Hard Evidence That a Dividend Payment Drops Stock Price

We pay income tax on the Realized dividend in the current year, regardless if withdrawn or reinvested. That is just a detail of congressional law which requires it. And since tax on the dividend will be paid, buying stock with any tax paid reinvested dividends increases cost basis, compensating by lowering the final taxable value when sold. Since 2012, the brokerages are required to keep track of dividends reinvested (adds to cost basis), but unknown cost basis due to older past reinvested dividends would be a tax problem when selling older investments. Tax on the compounded final result would be paid when sold.

The dividend price drop is real, well known, and automatic. Stock prices vary every day, which can obscure the dividend price drop. So it may be hard for market beginners to realize that the dividend drops price (with zero income gain) on the day dividends are paid, reinvested or not. I can show it clearly does drop, which produces zero dividend income on that day. For clear factual evidence of the price drop, just look at the stock or fund stock price history (those that show this detail), for example these several examples are from historical stock prices on Yahoo Finance (but not all stocks show the full dividend detail). More recent occurrences should also show the same thing.

Not all stocks show the full detail in this same way, but nevertheless, the price drop still happens. Stock dividends are taxed as a realized distribution, mostly Capital Gain (meaning gains taxed at a lower rate, if after 60 days, per USA IRS tax rules).

The dividend cash is transferred to you, as a withdrawal from your stock or fund value (including bond funds, but directly held bonds instead pay interest, like a bank). If you are in retirement, you might figure that since you pay tax on it, you might as well keep it, but the stock account does go down, and retirement can last many years. You can put it back by reinvesting it (especially if in a fund). Automatic reinvestment same day retains exactly the same previous stock dollar value, but at a lower price, and with a few extra free shares and a higher cost basis. And the next day opening may have other routine regular market price changes overnight too. You likely may notice the price drop in the larger cases, but it just means the dividend was paid.

This data in my table here is not updated very often to a later date, but it would remain the same point. The stock price changes a bit every day too, but on the day of the dividend, the "Adjusted Close" price simply subtracts the exact dividend from the Close Price. The dividend is the difference, and withdrawal changes that portion from unrealized gain to realized gain (which is taxed now). You can pocket it or put it back by reinvesting it. Reinvesting it becomes free shares. Yes, you did just buy them, but with money you just withdrew from the same stock and put back, so the difference is that you still have the same prior stock value, but more shares now (of the same value and at no extra cost, and you do owe some tax on the dividend now).

The fund price drops because the paid out dividend reduces the remaining value of the company. The prices of the company stocks in the fund are dropped (those that paid a dividend). In your view, the money simply transferred from the stocks you own to the cash now in your account, so your own value did not change on that day, but there was no gain either. On that dividend day, this becomes the stocks actual effective Close price. Other overnight market action can affect the next stock Open price too. However a mutual fund technically does not have an Open price, since it can only be bought or sold at the new Close price each evening day (with the exception of the new ETF funds which are regularly traded when the market is open). In these example instances, the stocks did also change a little more overnight until next day, but the idea about dividends is in the Close price.

There are differences in this reporting style among various funds and stocks. Some do not even show this added detail, but it is still present. Or there can be other factors, like stock splits in companies in the fund. Plus, the 500 individual S&P 500 fund companies may pay their dividend at various dates different than the S&P 500 fund passes the total along. In some cases you might notice that the Adjusted Close price drop does not exactly match the dividend subtraction. There can be other causes for price adjustment (splits, buying or spinning off other companies, etc), but the stated dividend amount shown is in fact reported correct, and that it includes the Capital Gains portion of the dividend. Most historical results are correct and complete, especially the adjusted price, but I've seen a few cases that the dividend value shown did not include the capital gains portion of the dividend. A part of the dividend is often taxed as capital gains, and the rest is called Dividend, which must be what sometime confuses their computer, but the actual dividend is the total of the parts. Even if the dividend value is not reported correctly, the adjusted close price should still be correct.

The Adjusted Close prices account for corporate actions like dividends, splits, spin offs (companies buying companies or selling divisions), or issuing or buying back shares. These are actions of individual companies, and a fund reflects the total. Some of these adjustment reasons affect all prior prices in the history. Here is a link to the math of Adjusted Close. Also other pages about Adjusted Close are found at Google. These clearly explain that dividends drop the share price equally. And of course, it does happen. Again, this is a known fact, and if a nonbeliever, I suggest seeing Google discussions about closing price adjustments.

The dividend (the gain portion of it) is taxed as if income, reinvested or not. Reinvested dividends are added to the fund Cost Basis (more shares are bought at the reduced price), so the cost basis does reduce future tax when sold (so the dividend is not taxed twice). The reinvested dividend is added to future price gains when reporting fund total return. Sure sounds like income, but look at the details that actually happen, and it cannot be found. On the day the dividend is paid, the stock or fund price is immediately adjusted down equally (so there was no income yet).

Reinvesting the dividend does buy more shares which will earn additional growth in the future, which is a big plus... the reduced price will recover and growth will be greater with more reinvested shares, as it accumulates and compounds (which is income then). That does not correct the situation, it simply ignores it. But if the dividend is instead withdrawn on that first day, then there is no additional gain, not on that day or any day. It was then just a withdrawal, different in that it leaves all of the same previous shares but at the lower price (whereas ordinary withdrawals reduce the shares but don't affect the price. However the effect on fund value is the same). So don't withdraw the dividends imagining it was income. Reinvest it for greater future growth, which in time will increase income.