DEFINITION of Homemade Dividends

Homemade dividends are a form of investment income that comes from the sale of a portion of one’s portfolio. This differs from traditional dividends that a company’s board of directors distributes to classes of its shareholders.

BREAKING DOWN Homemade Dividends

The ability of investors to create their own homemade dividends has, in part, given rise to questions about whether traditional dividends offer real value. To support this claim, some also argue that since a stock price will decrease by exactly the amount of the dividend on its ex-dividend date, it neutralizes any financial gain. This forms part of the dividend irrelevance theory.

A counterargument to the theory is that when an investor sells a portion of her portfolio, she ends up with fewer shares, resulting in a depleted asset base (despite a short-term monetary gain). In addition, the theory only holds true in a case with no taxes, no brokerage costs, and infinitely divisible shares.

Economists Merton Miller and Franco Modigliani were among the first to argue the irrelevance of corporate dividends in the early 1960s.

Homemade Dividends and Traditional Dividends

As noted above, a company’s board of directors declares dividends for their shareholders. Following the declaration date, the company establishes a record date to determine which shareholders are eligible to receive the distribution. The ex-dividend date (exactly two business days before the record date) denotes the final day a seller is still entitled to a dividend even if she/he has already to sold it to a buyer.

Normal dividends occur on a regularly (often monthly or quarterly) basis, while an extra or special dividend is a one-time distribution. Generally, a board declares special dividends after exceptionally strong earnings results or when a company wishes to make changes to its financial structure or spin off a subsidiary company.

Companies in the basic materials, oil and gas, banks and financial, healthcare and pharmaceuticals, and utility industries have among the highest historical dividend yields. In addition, companies structured as master limited partnerships (MLPs) and real estate investment trusts (REITs) are also top dividend payers. These companies are mature and have stable cash flows. In contrast, start-ups and other high-growth companies (e.g., new technology firms) rarely offer dividends. These companies usually prefer to reinvest any earnings they make into research and development.

In the absence of a steady stream of corporate dividends, or as part of a greater portfolio strategy, an individual may liquidate a portion of assets by placing an order with their broker to create homemade dividends.