Some of the best content can come from real-life questions and examples.
Here’s one from a friend a few days ago:
“Have you heard of the fund, MSTY? I put in $100 a month ago and it’s already paid out $7 in dividends in just one month. Why doesn’t everyone put all of their money here and make a 7% return each month?”
Before diving into the question, let’s take a small step back to identify what dividends are.
When investing in stocks, there are two ways to make money.
The first is through capital appreciation. This happens when you buy shares of a company at one price and then sell those shares later at a higher price. For example, if you purchased a share of Apple stock at $243 at the beginning of this year and sold it today at $269, you would have made $26.
The other way is through dividends. A dividend is a payment made by a company to its shareholders. Not every company pays a dividend (only around 60% of U.S. stocks do), and companies can change how much they pay and when they pay at any time, but regardless of the price fluctuations of the stock, you will receive a payment for simply owning it.
For some reason, we humans love a cash payout. It’s a big reason why so many people love the idea of investing in real estate, because there’s the potential to collect a rent check every month. Something about a scheduled, consistent payment makes us feel all warm and fuzzy inside.
So, a fund that offers a 7% dividend payout in just one month, like MSTY, is going to attract some attention.
MSTY is the ticker symbol for the YieldMax MSTR Option Income Strategy ETF. The details of this fund don’t matter to our discussion today; all you need to know is that it recently started paying out weekly dividends to its shareholders. Probably in an attempt to attract new investors.
Here’s the deal with dividends: they’re not free money.
A dividend is simply a return of capital.
Here’s an example: let’s say you have $100 and purchase a single share of stock worth $100 that pays a $10 per share dividend to its investors. That dividend payout comes out of the price of the stock. So after you get your dividend, you now have $10 extra in your pocket, but the value of your stock dropped to $90.
Your total wealth is still $100.
The dividend didn’t make you any richer. The company just gave you your own money back.
And if you want to get into more detail, you actually have less wealth now because dividends are subject to ordinary income tax. So, depending on your tax bracket, that $10 dividend is really only worth $7 or $8 after you pay the IRS.
Going back to MSTY, if you only care about how much a fund or stock pays in dividends, getting 7% over the course of a month is awesome. However, the price of MSTY is down 6.5% the day I’m writing this. Down 36% the past month. And down a whopping 68% the past year.
If you invested $100 into MSTY a month ago, yes, you would have received $7 in dividends. But you also would have lost $36 of investment value. Overall, your wealth decreased $29.
Dividend yield alone does not determine whether an investment is valuable or not. You can create a ton of wealth without any dividends at all. With stocks, you can always create your own dividends by simply selling some shares in the stocks or funds you own. It’s not the end of the world if you take some gains and enjoy your money.
In the end, total return is the only thing that matters.
Thanks for reading!
Jake Elm, CFP® is a financial advisor at Dentist Advisors. Jake a graduate of Utah Valley University’s nationally ranked Personal Financial Planning program. As a financial advisor at Dentist Advisors, he provides dentists with fiduciary guidance related to investments, debt, savings, taxes, and insurance. Learn more about Jake.