How do dividends work?

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Dividends are cash payments made by companies to their shareholders. They are usually funded from the company's profits. When a company earns profit, it can choose to reinvest it in the business, buy back its own shares, or distribute some of it to shareholders as dividends. Typically, companies have dividend policies that dictate how much of their profit is paid out in dividends, which may vary but generally aims to be consistent over time.

Here are the key points about dividends:

  1. Income Stream: Dividends provide an immediate cash return to shareholders, allowing them to realize income without selling shares 1.

  2. Not Guaranteed: Unlike interest from a bond, dividends are not guaranteed and can be cut or eliminated by the company at any time 2.

  3. Share Price Adjustment: When dividends are paid, the share price of the stock typically decreases by an amount approximately equal to the dividend paid, because the company's assets have decreased by the dividend amount distributed to shareholders 3.

    Dividend Income

    The guests explain how dividends are a way for shareholders to realize an immediate cash return on their investment without having to sell anything, essentially creating an income stream. However, dividends are not guaranteed and can fluctuate based on the company's profits.

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    122R | Dividend Deep Dive
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  4. Tax Considerations: Dividend income is taxable. However, if dividends are held in tax-advantaged accounts like a Roth IRA, taxes can be managed more efficiently 3.

Dividend policies may vary by region. In some countries, dividends are linked to the company’s profits, increasing or decreasing as profits change, whereas in others like the U.S., dividends may follow a more fixed model.

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