Dividends – Rewards for Risk

As a student, I used to always confuse dividend with ownership in the firm. Later when I started working as a finance person is when I fully understood how this works. The learning is not over because the finance sector is ever evolving and the number of new instruments coming up in the market is increasing. There are different names given to the returns on investment although it all means rewards for the risk undertaken. Yes, in simple terms dividends are rewards for the risk undertaken by the investor.

The Risk

In a saving economy, people are more interested in having their money deposited in the bank and earn whatever minimal return it provides. A good percentage of the lot invests in gold. People are afraid of losing their money if invested in other sources. This is the risk we are talking about. People who have taken up the chances and invested in funds definitely get higher returns in form of dividends. These returns are way higher than the returns from bank deposits or any other traditional form of saving because they are a share of the profit from company one has invested. Higher returns also come with high risk. There can be times when there are no dividends paid. So the investor must be prepared for both.

Re-investment Risk and Benefits

Dividends can be distributed in different ways to the investor. It can be paid in cash or in form of additional shares. Re-investment of dividends increases the investment value of the investor. It means more income for the investor in form of future dividends. Dividends in the form of stocks in the company also do not have the tax liability on the investor. Thus it increases the future earnings of the investor. This form of dividend also comes with its own set of risks. Risk of losing the earned dividends of the company fails to perform as expected in future.

Market Risks

Risks associated with dividend are proportional to the returns. The dividend payments are made at the sole discretion of the management/board of directors. It depends on the performance of the company, its dividend policy, and the general market conditions. If the company is going for expansion, they might decide to curtail dividend payments for re-investment. This might not be in the best interest of the investor. It markets are favorable and the company is performing well then the investor can expect a steady rise in his income

A savings account in a bank will earn a steady and safe income but it will not provide any appreciation to wealth whereas dividends promise higher returns and also increases the wealth of the investor. The question is the investor is ready to take the risk.