Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Ex Marks the Spot: Making the Most of Ex-Dividend Stocks

Many a divorcee will tell you that "ex" is a dirty word, but in the investing world, "ex" can be something lovely -- particularly ex-dividend stocks and the dividend-capture strategy that accompanies them. It's a relationship that (unlike a bad marriage) can be as lucrative as it is simple, and almost any investor can take advantage of the method that makes the dividend-capture strategy so effective.

How It Works
In a nutshell, the dividend-capture strategy is the act of purchasing a security for its dividend, capturing the dividend, and then selling the security to buy another about to pay a dividend. By doing this, investors can receive a steady stream of dividend income instead of waiting for an individual holding to pay its regular dividend.

To make this work, investors must buy the security prior to the ex-dividend date to ensure they are a shareholder of record when the dividend is paid (remember that it may take time to settle the transaction, meaning the investors must buy several days prior to the ex-dividend date). In simple terms, the ex-dividend date is the day new buyers of a security are no longer eligible to receive the upcoming dividend.

Let's say an investor purchases a stock that pays quarterly dividends (most companies pay on a quarterly basis). In this case, the investor would receive four dividend payments throughout the year. However, if that same investor uses a dividend-capture strategy, then he or she would not hold the stock for a full year. Instead, the investor would purchase the stock before its ex-dividend date and would sell it 61 days later. After the sale, he or she would then turn around and plow that money back into another company that is about to pay a sizable dividend payment.

Assuming a 61-day holding period for each captured dividend, this investor would be able to pocket six dividend payments during the year (365 days divided by 61 equals 6) instead of the traditional four -- that's 50% more dividends from the same investment dollars.

Things to Consider
Many investors and mutual funds produce attractive returns with the dividend-capture strategy, but it does involve higher trading costs and the risk that share prices will not move as expected. After all, in theory, investors should be able to quickly buy and sell a number of securities near their ex-dividend dates and capture numerous dividends. However, in practice this is not always the case.

First, whenever a firm announces a dividend, often the share price ramps up prior to the ex-dividend date because investors implicitly factor the upcoming dividend payment into the price. Thus, investors buying after the dividend announcement and before the ex-dividend date often pay a higher price for the security.

Once the stock "goes ex-dividend," however, the price usually falls by the approximate value of the dividend payment, because after the ex-dividend date, buyers of the stock or fund will not receive the upcoming dividend. These actions result in a higher buy price and a lower sell price in many circumstances.

That's why taxes are another consideration with the dividend-capture strategy. Investors using taxable accounts to implement dividend-capture strategies might find themselves incurring unrealized capital losses (because the share price is below what they originally paid) but owing taxes on the dividends received. Furthermore, dividends paid on securities held for fewer than 61 days are subject to taxation at the investor's regular income tax rate. Therefore, someone who buys a stock the day before the ex-dividend date and then sells it two days later will be subject to a tax rate of up to 35% (depending on the investor's tax bracket) instead of 15% if he or she held the stock for 61 days.#-ad_banner_2-#Nonetheless, the dividend-capture strategy is still popular because it allows investors to gain more payments per year than just holding on to one security. By employing this strategy, investors can capture more dividends in any given year from the same investment dollars, making it a way investors can boost their returns from the markets while creating a steady stream of dividend income. Likewise, those looking for tax-advantage dividends may like that they can earn more dividend income in a year than under normal circumstances.