One of the benefits of investing in stock is the opportunity to earn cash dividends. This allows you to earn investment income without losing the ability to earn gains as your stock increases in value. What you do with your cash dividends is up to you, and you can hold them for any length of time as you would with any other cash payment you receive.
How Dividends Work
Cash dividends, along with stock dividends, are incentives that some companies offer to their shareholders. Once each year or quarter, a company that issues cash dividends makes a payment to each investor on a per-share basis. This payment occurs regardless of whether the stock lost or gained value during the previous year or fiscal quarter. Different companies pay dividends at different rates. The company's board of directors can elect to reduce, increase or cancel the dividend as it sees fit.
Receiving Cash Dividends
Cash dividends usually arrive as checks to investors. Since the dividend pays on a per-share basis, the more shares of a company you own, the larger your dividend check. You can deposit dividend checks into your bank account and spend the money at any time, or save it indefinitely. Dividend income is taxable. The company that pays you a dividend will submit a 1099-DIV form at the end of the year so that you can claim your dividends on your income taxes.
The one case where you can't keep your dividend for a long time is if you plan to reinvest it through a dividend reinvestment plan. These plans, offered by many companies that pay dividends, allow shareholders to buy additional shares with their dividend income. If you reinvest your dividends you can't hold the cash you earn. In most cases you won't even receive a check. Instead, you'll receive a statement that indicates how much new stock you own from reinvesting your dividends, which will depend on the stock's market price. Reinvesting dividends prevents you from keeping the cash, but it also allows you to avoid taxes on your dividend income and increases the value of your total investment. It also increases the value of your next dividend payment, since you own additional shares of stock.
Dividend Holding Strategies
Reinvesting dividends is generally a reasonable decision since it equates to buying more stock in a company that you already decided was a wise investment. Plus, you're buying it with money you earned from the very same investment. However, you may also choose to receive dividends as cash and hold them for the future. If you have a major purchase coming up, such as a new car, you may choose to cancel your dividend reinvestment plan and instead receive cash that you use to make a larger down payment on the car, avoiding finance charges on a large auto loan. If the stock that you earn a dividend from is losing value, you may also prefer to hold the dividend cash in a bank account where it is safe rather than buying shares that may continue to decrease in value.
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