Help, I don't understand dividends

Your essential guide to getting dividend income from the stock market

Savers have had to contend with very low rates of interest on cash for more than seven years, resulting in pent-up demand for alternative sources of income. Dividends from stocks and funds have been among the most popular options.
 

The Bank of England has held official interest rates in the UK at 0.5% since March 2009; and it is now eight years since rates were 5% or more. Put simply, you may struggle to get any worthwhile level of interest on cash in the bank unless the UK economy experiences a surge in growth and the Bank of England finds reasons to raise rates to cool inflation.

Investing in the stock market can provide a better rate of return than cash in the bank as compensation for the higher risks that come with putting money into stocks and funds.

If you are new to investing or don't fully understand how to go about obtaining dividends, we now give you a step-by-step guide to the world of income.

1. What are dividends?
Think of them like the monthly or annual interest payment you get on cash in the bank. Rather than the bank paying you money, you are instead getting a cash reward from the company or fund in which you have invested.

2. Does every company or fund pay one?
No. There is no obligation for any company or fund to pay you dividends; they are free to start paying and then scale back or cancel them in the future.

3. Why are they paid in the first place?
They are management's vote of confidence in a company's future prospects. They tend to be paid out of cash generated from operations that isn't needed for investment in the business. A fund will have stakes in lots of different companies who may pay dividends, so it collects those payments as a shareholder and then distributes some or all of that cash to its own investors.

4. I want to buy a stock or fund to get its dividend – is there a cut-off point to qualify?
Companies and funds will publish dates in their financial results that specify the timetable for dividend payments. The ex-dividend date is the most important. This is the point at which the share price will adjust to assume the money had been allocated to the qualifying investors. You need to own the shares BEFORE this date to qualify for the dividend.

5. How quickly does the money get paid?
Payment periods vary from company to company, or fund to fund. Some will pay you the cash in a matter of weeks; others can take several months to distribute the money. The exact payment date will appear alongside the ex-dividend date in the financial results.

6. How often are dividends paid?
Again, the frequency is variable. The 'norm' is for companies to pay every six months. Funds are increasingly paying dividends on a quarterly basis; there are even some who pay every month. This is because their underlying investments will probably be paying dividends at different times through the year, so the fund scoops up what's come in every quarter and then redistributes the cash to its own shareholders.

7. Are dividends always paid in cash?
Generally, yes. A few companies will also offer payment in new shares – known as 'scrip' – although these are becoming increasingly rare.

8. How do I work out the dividend yield?
Banks will always publish the interest rates paid on cash deposits. You won't get that with investments because the rate of return – also known as 'yield' – is based on the price at which you first bought the shares. For example, if you bought shares in Vodafone at 200p and it paid 10p in dividends in a single year, your yield is 5%. It can be calculated as follows: total dividend for the year (so add up the half year and full year payment) divided by the price at which you bought the shares, multiplied by 100.

Four examples of dividend-paying stocks and funds

Admiral
The car insurance company is forecast by stockbroker Numis to pay a 6.3% yield for 2016, based on a £19.27 share price at the time of writing. Admiral has increased its dividend every year apart from one since joining the stock market in 2004.

iShares UK Dividend
The exchange-traded fund offers diversified exposure to a universe of the highest yielding stocks on the FTSE 350 index. The fund distributes income on a quarterly basis and has a historic yield of 5.75% at the time of writing. It provides access to the dividend streams of 50 companies, thereby avoiding the risk of seeing your income wiped out by dividend cuts at one or two names, for an ongoing charge of 0.4%.

JPM Multi Asset Income
The fund is currently yielding 4.15%. It looks to achieve the best risk adjusted income by investing in a wide range of underlying assets including equities, fixed interest and real estate funds. The income can be taken monthly, quarterly or reinvested for growth.

Aviva Investors Multi-Strategy Target Income Fund
This fund aims to produce an annual income yield of 4% above the base rate regardless of the prevailing conditions, while preserving capital and keeping the volatility to less than half that of global equities over rolling three-year periods. The fund managers invest across the bond and equity markets and sell various options to generate an additional income.