Why invest in the first place?

I know you have been following along faithfully (of course!) and have set up an Automatic Savings Plan (ASP) that is currently going into investments. That means, each month, you are contributing a set amount of money into your accounts (RRSP, TFSA or non-registered) and investing them in either low-cost index mutual funds or Exchange Traded Funds (ETFs).  So the money is going to start rolling in, right? Wait… how exactly does the money start rolling in?

There are a couple ways to earn income on your investments:

  1. Interest from bonds. When you are lending money to either the government or corporate companies, they will, in return, pay you money for it. This is no different than when you are borrowing money from credit card companies or money for a mortgage from the bank; you will be paying them money (called interest) for the privilege of using it. Therefore, when you own bonds as investments, you will earn a steady income from it.
  2. Dividends from stocks. When you buy shares in a company, you are providing them with money that is ideally used to grow the company’s business, and consequently, help them increase the earnings and profits for the company. The board of the directors may then decide to share these earnings and profits with you, the shareholder. This payout is called dividends, and is usually quoted as a dollar amount per share. For example, if the company chooses to pay $0.25 per share, and you own 1,000 shares, expect to receive a dividend payment of $250. One thing to note about dividends is the ex-dividend date. It is the date in which you have to own shares in the company to be eligible for the dividend, which will be paid out at a later date. For example, say the ex-dividend date is February 23. If you own shares on February 22, you will be entitled to the dividend payout. If you buy the shares on February 23 (therefore not owning the shares on February 22), you will NOT be eligible for the next dividend payout.
  3. Capital gains. Ultimately, this is the main reason why most people invest in stocks (and ETFs and index mutual funds). If the company is earning money and profits, the value of the company is also (hopefully!) growing. As the value of the company increases, the cost of buying shares in the company also increases. Say you buy a share in company ABC today for $10. The company is profitable and in 2 years, a share in company ABC now costs $25 to own. A capital gain results when you buy a share at one price, and sell it later at a higher price. For example, say you bought a share in Company ABC for $10, and 2 years later, sell it to someone else for $25, then the capital gain for the investment will be $15 ($25 – $10 = $15). NOTE: This is a very simplistic view! Unfortunately, the above scenario does not always occur as the stock market is an entity that can fluctuate based on external factors such as government policies, economic environment, civil unrest or even just the popularity of a product or brand.

Clear as mud, right? 🙂 Hopefully, this will shed a bit of light on why people choose to invest their money in stock markets or ETFs or mutual funds in the first place.

Final question: Say you own shares in company ABC and you decide to sell them on February 23. If the ex-dividend date is February 23, will you be entitled to the dividend payout?

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5 Comments (+add yours?)

  1. Liquid
    Feb 23, 2012 @ 22:28:14

    I’m not sure, but I would think you are still entitled to that dividend payout even if you sell your shares on the ex-dividend date. A big reason to invest for me is to keep up with inflation. Money just sitting in the bank today will probably lose 2.5% of its value by next year.

    Reply

    • Vicky Vo
      Feb 24, 2012 @ 04:03:10

      Correct! You would be entitled to the dividend payout!

      I definitely agree that investing in the stock market is a good hedge against inflation, but I think it would depend on your time frame for your money. If you need the money in the short term, you might be forced to sell in a down market!

      Thanks for dropping by!

      Reply

  2. The Dividend Ninja
    Feb 24, 2012 @ 03:13:40

    Hi Vicky,

    There are two seperate things going on here, the “ex-dividend” and the “record” date.

    The “record date” is the actual date you must be a shareholder of the company to be entitled to recieve the dividend. In other words you must be on “record” as a shareholder, no problem for buy-and-hold investors. You could sell your stock after the record date and still collect the dividend. But if you sold before the record date you would not collect the dividend.

    The “ex-dividend date” is three days before the record date. Since it takes three days to settle all stock transactions, you must buy your stock before the ex-dividend date to be on record to collect the dividend. If you buy the stock on or after the ex-dividend date, you will not be considered to be on record, and will not be eligible to collect the dividend. If you sell your stock before the record-date you will not be eligible for the dividend.

    Cheers! 🙂

    Reply

  3. The Dividend Ninja
    Feb 24, 2012 @ 03:32:36

    Correction:
    My mistake Vicky, one must hold the stock until the ex-dividend date. If you were to sell the stock on the ex-dividend date or afterwards, you would still be entitled to the dividend payment – becuase it still takes three days to settle the trade. So you are on recrod… I personally would not sell on the ex-dividend date 😉

    Reply

    • Vicky Vo
      Feb 24, 2012 @ 04:04:58

      Haha, I wouldn’t be selling on that date either! But, technically, you are on record and entitled to the dividend!

      Thanks for dropping by! 🙂

      Reply

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