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If you’re ready to invest better, Global Future Capital Stock Advisor can help. You don’t need a degree in Finance to grow your wealth. You just need a few minutes a month, and some great stock recommendations – and that’s what we’re here for.

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What is Dividend?

A dividend is a token reward paid to the shareholders for their investment in a company’s equity, and it usually originates from the company’s net profits. While the major portion of the profits is kept within the company as retained earnings, which represent the money to be used for the company’s ongoing and future business activities, the remainder can be allocated to the shareholders as a dividend. However, at times, companies may still make dividend payments even when they don’t make suitable profits. They may do so to maintain their established track record of making regular dividend payments.

The board of directors can choose to issue dividends over various time frames and with different payout rates. Dividends can be paid at a scheduled frequency, like monthly, quarterly or annually. For example, Walmart Inc.  and Unilever make regular quarterly dividend payments. Additionally, companies can also issue non-recurring special dividends either individually or in addition to a scheduled dividend. Backed by strong business performance and an improved financial outlook.

 

Why Companies Pay Dividends

Companies pay dividends for a variety of reasons. These reasons can have different implications and interpretations for investors.

Dividends are expected by the shareholders as a reward for their trust in a company and the company management aims to honor this sentiment by delivering a robust track record of dividend payments. Dividend payments reflect positively on a company and help maintain investors’ trust. Dividends are also preferred by shareholders as they are treated as tax-free income for shareholders in many jurisdictions, while capital gains realized through the sale of a share whose price has increased is taxable. Traders who look for short-term gains may also prefer getting dividend payments that offer instant tax-free gains.
A high-value dividend declaration can indicate that the company is doing well and has generated good profits. But it can also indicate that the company does not have suitable projects to generate better returns. Therefore, it is utilizing its cash to pay shareholders instead of reinvesting it into growth.
If a company has a long history of past dividend payments, reducing or eliminating the dividend amount may signal to investors that the company could be in trouble. The announcement of a 50% decrease in dividends from General Electric Co, one of the biggest American industrial companies, was accompanied by a decline of more than seven percent in GE’s stock price on November 13, 2017.
A reduction in dividend amount or a decision against making any dividend payment may not necessarily translate into bad news about a company. It may be possible that the company’s management has better plans for investing the money, given its financials and operations. For example, a company’s management may choose to invest in a high return project that has the potential to magnify returns for shareholders in the long run as compared to the petty gains they will realize through dividend payments.

The Power of Compound Interest

Warren Buffett and Albert Einstein once noted that the most powerful force in the universe was the principle of compounding. In investing, this manifests itself through something called compound interest.

In simple terms, compound interest means that you begin to earn interest income on your interest income, resulting in your money growing at an ever-accelerating rate.

In other words, if you have $500 and earn 10% in interest, you have $550. Then, if you earn 10% of interest on that, you end up with $605. And so on and so forth until you have a very hefty sum of money.

It is the reason for the success of every person on the Forbes 400 list, and anyone can take advantage of the benefits through a disciplined investing program. Benjamin Franklin was famous explaining to people that it was the best way he knew how to get rich.

 

The Three Things That Determine Your Compound Interest Returns

Three things will influence the rate at which your money compounds. These are:

  1. The interest rate you earn on your investment, or the profit you earn. If you are investing in stocks, this would be your total profit from capital gains and dividends
  2. Time. The longer your money can remain uninterrupted, the bigger your fortune can grow. It’s no different than planting a tree. Naturally, the tree is going to be larger when it is 50 years old than it was when it was 20 years old.
  3. The tax rate, and the timing of the tax, you have to pay to the government. You will end up with far more money if you don’t have to pay taxes at all, or until the end of the compounding period rather than at the end of each year. That’s why accounts such as the traditional IRA or Roth IRA, 401(k), SEP-IRA, and such are so important.

 

Compound Interest and the Time Value of Money

The concept of compound interest is the foundation of the time value of money, which states that the value of money changes to a person depending upon when it is received. Earning $100 today is preferable to earning $100 several years from now. After all, if you have it in your hand immediately, you can invest it to generate dividends and interest income. After that, you can spend it on things you want, you can pay down your debt to lower your interest expense, or you can give it to charity. By postponing the receipt of the $100, you are losing something economists call opportunity cost.

When you learn about the time value of money, you’ll learn the formulas that show you how to calculate compound interest. This will empower you to answer questions such as,
”If I need $1 million for retirement 30 years from now, and I can save $800 per month and earn 8% per year on my investments, will I reach my goal? I’m putting $12,000 per year into variable annuities that I expect to earn 7% for 18 years. How much will they be worth, when I’m ready to cash out of the investment?”

Compound Interest Results Over Time

The best way to understand these concepts is to put them into a compound interest table that shows you just how substantially your wealth can be helped, or hindered, by small changes over time.

Imagine you have an investor who sets aside a lump sum of $10,000. Take a look at the compound interest chart at the bottom of the page to see the influence of time and rate of return on his ultimate wealth. Once you understand this, it becomes evident that saving money alone doesn’t explain why some people have bigger fortunes than others.

For instance, a 20-year-old that invests $10,000 today and parks it in Treasury bills, earning 4% on average for the next 50 years, will find himself with $71,067 if the purchases were made through ​a tax free account such as a Roth IRA. Had he invested in stocks and real estate, earning a 12% average rate of return over the same time, he would have ended up with $2,890,022. Adding higher returning asset classes would result in more than 40 times more money thanks to the power of compound interest.

One glance at the compound interest chart and you may want to do whatever it takes to earn the higher rate of return—in this case, 16%. That can be dangerous. Unless you know what you’re doing, no matter how successful you are along the way, you always want to avoid the possibility of losing all your savings. In finance, 20%, 40%, 60% returns in the first years are great, but if there is a -80%, -90%, or -100% in there anywhere, it’s game over because you will have lost your capital. Without capital, you can’t make investments that will later grow.

Benjamin Graham, known as the Father of Value Investing, was aware of this risk when he said that more money had been lost reaching for a little extra return or yield than has been lost to speculating. He warned that it is one of the greatest temptations new investors face when building a portfolio.

Compound Interest Tables – The Value of $10,000 Invested 

 

Kolom1 4% 8% 12% 16%
10 Years $14,802 $21,589 $31,058 $44,114
20 Years $21,911 $46,610 $96,463 $194,608
30 Years $32,434 $100,627 $299,600 $858,500
40 Years $48,010 $217,245 $930,510 $3,787,212
50 Years $71,067 $469,016 $2,890,022 $16,707,038

 

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