A bond typically pays a fixed rate of interest each year, called its coupon payment. The payment is a percentage of the bond's face value. Unlike stock dividends, bond interest is guaranteed and the amount of the payment is established upfront. Investors researching funds need to know whether the historical returns they see on the fund fact sheet include the reinvestment of dividends—in other words, don't inflate its potential returns by assuming it includes the growth rate plus dividend distributions.
Aggregation and Timing Most companies that pay dividends on preferred stock or common stock or both typically do so on a quarterly basis. There are companies that pay on a semi-annual basis and even a few that issue dividend checks monthly. Mutual funds collect this income and then distribute it to shareholders on a pro-rata basis. All funds are legally required to distribute their accumulated dividends at least once a year. Those that are geared towards current income will pay dividends on a quarterly or even monthly basis.
But many others only pay out dividends on an annual or semiannual basis in order to minimize administrative costs. Some funds may, in fact, withhold some dividends in certain months and then pay them out in a later month in order to achieve a more level distribution of income. Interest that is earned from fixed-income securities in their portfolios also is aggregated and distributed to shareholders on a pro-rata basis.
These may appear on the statements as dividend income. About Dividend Reinvestment Some investors, especially those who are not retirees, prefer to reinvest their dividends rather than receive a payout. Establishing a dividend reinvestment plan is easy with mutual funds. The investor simply notifies the broker or fund company to automatically reinvest the cash into additional shares. Shareholders can also use their dividends to purchase shares of a different fund. The fund company usually permits this as long as the second fund is within its own family.
Independent brokers and investment firms often do this regardless of what fund is being purchased. Tax Reporting and Share Pricing Funds that pay dividends will reduce their share prices by the amount of the dividend being paid on the ex-dividend date in the same manner as individual stocks. Any shareholder who owned shares on the record date will be paid this dividend.
Unless they come from funds within an individual retirement account IRA or tax-advantaged retirement plan, all dividends are now treated as ordinary income in the year that they are paid. Mutual fund dividends are reported on Form DIV like dividends from individual stocks. The rules for reinvestment, aggregation, and pricing are also largely the same for master limited partnerships, real estate investment trusts, target-date funds, and exchange-traded funds ETFs that pay dividends.
Article Sources Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. Building a portfolio from scratch of specific stocks is also a possibility. This does come at a cost. The basic plan allows only three trades during the quarter, which is a problem for those whose strategy is to make multiple purchases each month.
As one who seeks to minimize costs which is one of the real powers with dividend reinvestment plans , this just does not work for me. The first way to DRiP that does make sense is to work through a broker, not something that would have been feasible years ago. This does not fit into the traditional mold of dividend reinvestment programs but achieves its goal in the same manner. For this example I will look at TD Ameritrade. Their platform advertises fee-free purchases of stock, so multiple purchases of companies could be done each month.
The company also offers a dividend reinvestment program without cost, so that barrier is reached. And finally, partial shares can be owned. There may be limitations on these offerings that do not work. For instance, when making a purchase one needs to specify the number of shares as opposed to the purchase amount. This means that you cannot purchase fractional shares.
That said, for the advantages TD Ameritrade offers, this is probably going to be an acceptable limitation. At the time of this writing 10 Dec there could be a small catch. TD Ameritrade is going to be acquired by Charles Schwab. I have had experience with this in the past. I originally purchased stocks through a company long forgotten that was acquired by Zecco, which was then acquired by Ally. The reasons for selecting a company to do business with may not be transferred to the new company, so one simply needs to be aware of the situation and be ready to reevaluate their decision.
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