The ex-dividend date is the demarkation date when investors who hold a common stock will receive the dividend payment. Also known as the ex-date, this day had been one business day prior to the dividend record date. On May 28, 2024, the ex-dividend date and record date became the same day, due to the move to t+1 settlement. There are ways that investors can use the ex-dividend date to their advantage.
A common stock's ex-dividend price behavior is a continuing source of confusion to investors. Read on to learn about what happens to the market value of a share of stock when it goes "ex" (as in ex-dividend) and why. We'll also provide some ideas that may help you hang on to more of your hard-earned dollars.
Key Takeaways
- When buying and selling stock, it's important to pay attention not just to the ex-dividend date and record date, but also the settlement date in order to avoid missing a dividend, or receiving an unwanted one and its tax consequences.
- The value of a share of stock goes down by about the dividend amount when the stock goes ex-dividend.
- Investors who own mutual funds, stocks, and other securities should find out the ex-dividend date for those investments and evaluate how the distribution will affect their tax bill.
How Does It Work?
Let's take, for example, a company called Jack Russell Terriers Inc. that trades on the Nasdaq under the truly appropriate symbol "HYPER" and that's currently priced at $10 per share. Due to the popularity of Jack Russell Terriers, HYPER has had record earnings, so the board of directors decided to declare a special extra dividend of $1 per share with a record date of Tuesday, June 11, 2024. The ex-dividend date, or ex-date, will be the same day.
If you buy the stock on or before Monday, June 10, you will get the $1 dividend because the stock is trading with (or "cum") dividend. If you wait to buy the stock until Tuesday, June 11, you are not entitled to the $1 annual dividend. Keep in mind that the purchase date and ownership dates differ. In 2017, the settlement date for marketable securities was reduced from three to two days. On May 28, 2024, this was further reduced from two days to one day. So, to own shares on the record date—i.e., to be a shareholder of record for Tuesday, June 11—you have to buy the shares a day before the ex-dividend date which is now the same as the record date. Further, if you sell the shares before the ex-date, you won't be seen as a shareholder and won't receive the dividend.
The Stock's Value
What will happen to the value of the stock between the close on Monday and the open on Tuesday? Well, if you think about it within the context of actual value, this stock is truly worth $1 less on Tuesday, June 11, than it was on Monday,June 10. Soits price should drop by approximately this amount between the close of business on Monday and the open of business on Tuesday.
Following the move to t+1 settlement on May 28, 2024, the ex-dividend date and record date are now the same. In order to receive the dividend and be a shareholder of record, you must purchase the stock at least one day prior to this date.
In general, we would expect that the value of a share of HYPER stock would go down by the dividend amount ($1) when the stock goes ex-dividend. Taxes are also a factor that can affect the value of dividends and need to be considered. Assuming that HYPER pays a qualified dividend, it would be taxed at 0%, 15%, or 20% depending on the recipient's income.
Let's say that Bob is excited about HYPER's earnings and buys 100 shares on Monday June 10, for settlement on Tuesday, June 11, at a price of $10 per share. What happens? As you know, the ex-date is now the same date as the date of record. The stock will go ex-dividend (trade without entitlement to the dividend payment) on Tuesday, June 11, 2024. Bob already owns the stock on Tuesday, June 11, because he purchased the stock with entitlement to the dividend on the previous day.
In other words, Bob will receive a dividend distribution of $100 ($1 x 100 shares). His check will be mailed on Wednesday, June 12, 2024 (dividend checks are mailed or electronically transferred out the day after the record date). When the stock goes ex-dividend on Tuesday, June 11, its value will drop by about $1. So, on the following day, in theory, the stock should be trading for approximately $9.00.
Think Before You Act
Now that you understand how the price behaves, let's consider whether Bob needs to be concerned about this or not. If he is buying HYPER in a qualified account (in other words, an IRA, 401(k) or any other tax-deferred account), then he should not worry too much, because he doesn't owe taxes until he withdraws his money or, if he makes his purchase in a Roth IRA, they are not due at all.
However, if Bob buys HYPER in a regular taxable account, he really needs to be careful. Let's say Bob just can't wait to get his paws on some HYPER shares, and he buys them with a settlement date of Monday, June 10 (in other words, when they are trading with entitlement to the dividend). He pays $10 per share. Suppose that the very next day, HYPER drops to approximately $9.00. Bob will have an unrealized capital loss and, to add insult to injury, he will have to pay taxes on the dividend he receives. Bob's portfolio will lose money on paper and he will owe a portion of the $100 in dividends that he receives to the IRS. If Bob didn't value having the dividend payment, he could have bought HYPER shares on the first ex-dividend day and paid the lower price. However, if Bob wanted the dividend payment to reinvest in the company or as income, and he expects the share price to quickly recover from the dividend payment, it then makes sense to purchase the stock before it goes ex-dividend. The right decision will always depend on the investor's own situation and personal preferences.
Mutual Funds
This scenario also needs to be considered when buying mutual funds, which pay out profits to fund shareholders.
By law, mutual funds must distribute profits from the sale of securities in the fund to the fundholders each year in the form of income dividends and/or short- and long-term capital gains, even if the value of their actual mutual fund's NAV drops. This distribution to the fundholders is a taxable event, even if the fundholder is reinvesting dividends and capital gains.
Why don't mutual funds just keep the profits and reinvest them? Under the Investment Company Act of 1940, a fund is allowed to distribute virtually all of its earnings to the fund shareholders and avoid paying corporate tax on its trading profits. By doing this, it can lower fund expenses (taxes are, of course, a cost of doing business), which increases returns and makes the fund's results appear much more robust.
What's an investor to do? Well, just like the HYPER example, investors should find out when the fund is going to go "ex" (this usually occurs at the end of the year, but start calling your fund in October). If you have current investments in the fund, evaluate how this distribution will affect your tax bill. It's always best to be prepared for tax events when investing ,and know how they'll affect you. If you are thinking about making a new or additional purchase to a mutual fund, you may save money by doing so after the ex-dividend date. On the other hand, you miss the dividend payment in that case. Each investor much decide what they value more.
The Bottom Line
In order to receive a dividend, you must purchase a security before the ex-dividend date. On May 28, 2024, the ex-dividend date became the same as the date of record with the move to t+1 settlement. A security tends to drop by the the dividend amount on the ex-dividend date. Additionally, dividends are a form of taxable income. Investors should keep these things in my mind when choosing when to purchase investments.
