When one of your stocks pays a dividend, there will be one day when the stock price drops because of the dividend payment. This ex-dividend date effect actually works to maintain your investment value. This effect is temporary. Do not worry that the share price drop from the dividend is permanent: Dividends increase your investment return.
When one of your stocks pays a dividend, the company will declare the amount of the dividend, the record date and the payment date. The payment date is when the money will be deposited to your brokerage account. The record date determines which investors are entitled to receive the dividend. If you own shares on the record date, you get the dividend. If you buy shares and your ownership is not finalized until after the record date, you will not receive the declared dividend.
When you buy or sell stocks, Securities and Exchange Commission rules allow three business days for the trade to be official or settle. This three-day settlement means that you are not the actual owner of shares you buy until three business days later. So to own stock on a dividend record date, you must have purchased the shares at least three days in advance. As a result, someone who buys shares two days before the record date will not be a shareholder of record and will not receive the dividend. A stock is said to go ex-dividend two days before the record date.
On the ex-dividend date, the share price drops by the amount of dividend to be paid. This price drop actually maintains the investment value of the stock. Consider a stock with a share price of $50 the day before going ex-dividend with a $1 dividend to be paid. On the ex-dividend date, the share price will open at $49. The investor who owned the shares the day before now owns shares worth $49 and will receive the $1 dividend for a total value of $50 per share.
A Repeating Event
Most dividend paying stocks pay dividends quarterly. So four times a year the share price drops by the amount of the dividend. However, if you look at the share price over time, you will not see an erosion in the share value due to the ex-dividend price drops. After going ex-dividend, the share price will eventually recover, although the actual recovery may be hard to spot in the daily price swings of the stock market.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.