Updated: August 6, 2013
Savvy income investors have long known of a simple investment strategy that allows you to capture more dividends with the same investing dollars. It's not hard, but it will require a little research. On the plus side, the rewards can be great -- you can easily earn yields 50% higher than normal.
Basically, this strategy enables investors to lock in two additional dividend payments each year for the same investment dollars. Instead of four quarterly dividend payments a year, investors can use this strategy to earn as many as six dividend payments. The best part is that the dividends still qualify for the 15% dividend tax rate.
A dividend capture involves purchasing a stock for its dividend, collecting the dividend, selling the stock, and then using the proceeds to buy another stock ready to pay a dividend. Before getting into the details of how dividend capture works, you need to understand the terminology and sequence of events leading up to a dividend payment.
Understanding Dividend Lingo
The process begins with a company declaring the date it will pay its next dividend. This is called the declaration date, and it is usually announced by a press release. The dividend can only be collected by registered holders of the stock on a certain date, known as the record date. The ex-dividend date usually comes two days before the record date. This is the first day the stock trades without the right to pay a dividend to new shareholders. The dividend payment is made on the payment date, which is typically scheduled four weeks after the ex-dividend date.
Because of how dividend payments are timed, you can purchase a stock one trading day before the ex-dividend date and still collect the dividend, even if you hold the stock for only one day and sell it on the ex-dividend date.
How to Use Dividend Capture
The main benefit of a dividend-capture strategy is it enables an investor to collect more dividends in a year with the same investment dollars. For example, an investor who purchases a stock paying quarterly dividends receives four dividend payments a year. However, if he purchases a stock before its ex-dividend date and sells it 61 days later (the minimum days you must hold a stock to qualify for the reduced 15% dividend tax rate), the investor would be able to pocket six dividend payments during the year (365 days/ 61 days = 6) instead of the traditional four. That equates to 50% more dividends for the same investment.
As I mentioned, this method only works if you hold a stock for at least 61 days if you want to qualify for the reduced tax rate. If you sell the stock sooner than the 61-day timeframe, your dividend payment may be taxed as ordinary income up to a 35% rate (depending on your tax bracket).
If you want to try a dividend-capture strategy for yourself, you will need a list of stocks going ex-dividend (or a dividend calendar). .com provides a calendar of stock ex-dividend dates over a period of four weeks. The calendar shows the dividend amount, the ex-dividend date and the dividend payment date. You can also find ex-dividend and payment dates for individual stocks on the Key Statistics page of Yahoo Finance.
Most dividend-capture strategies assume you can lock in capital gains as well as extra dividends, because the price of a stock should rise prior to the ex-dividend date in anticipation of the dividend, drop by the value of the dividend on the ex-dividend date, and rise again with the approach of the next payment date. In other words, a stock paying a $0.25 quarterly dividend and closing at $15.00 one day before the ex-dividend date should trade at $14.75 on the ex-dividend date and rise to at least $15 before the next announcement date.
Some dividend capture strategies recommend purchasing the stock before the dividend announcement, based on the belief that the announcement triggers a rise in the share price. The truth is, however, market forces often overpower the ex-dividend effect and there is no guarantee a stock price will bounce back to pre-dividend levels. For that reason, dividend capture is not a foolproof method for generating capital gains.
However, just because profits aren't guaranteed doesn't mean you shouldn't pay attention to ex-dividend dates when buying a stock. By purchasing a stock a few weeks before the ex-dividend date, or even better, before the dividend announcement date, you benefit from the dividend in the short-term, while possibly owning a stock you like for the longer-term. This strategy combines an immediate return on your investment with the potential for long-term capital gains.
The Investing Answer: This strategy takes a little bit of research, and individual yields are usually modest. However, even if I only receive an extra 1% to 2% in dividends, every little bit helps, and the cumulative effect of two extra dividends each year can add meaningful income.