Many of you have heard me talk about Dividend funds over the past couple years. I am obviously a fan. I can think of nothing better than getting paid to just sit and wait.
There are a few different types of Dividend funds, the tradition Large Cap fund, and the Dividend Growth fund. These can then be broken down into Canadian, US, Global or sector funds. Although they generally hold different types of investments, they basically operate in the same way.
A Large Cap Dividend fund, formerly known as a “Blue Chip” fund, is made up of the big boys of the stock market. Banks, Insurance Companies, Utilities, Pipelines. These companies have a large enough capitalization (number of stocks outstanding) that their price usually doesn’t move a great deal on a daily basis. Their stock price just grows at a rather slow and steady pace over a longer period of time. Boring! And for a long term investor, boring is fabulous.
A Dividend Growth fund is usually made up of a mix of larger and smaller companies, who may have more potential for year over year corporate growth than the big guys. This can provide more capital apreciation than you might get from a Large Cap fund, but because of this, can introduce more volatility, and the price swings of the individual stocks in the fund can be greater. They still pay a dividend every three months, just like the big guys. Not as boring, but it’s still not exciting enough to be a conversational topic at your next dinner party.
So why is boring good? We are interested in the main underlying feature of any Dividend fund, The Dividend. Every three months these companies pay out their corporate profits in a quarterly dividend of cash to their shareholders. In this case, the fund, and and fund holders, you and me.
This is the good part –
At the end of each year, the fund manager takes all those dividends they have collected during the year, and pays them out to the unit holders of the fund (you) in the form of more shares (units) of the fund. So now, not only have the basic underlying stocks in the fund increased in value, and thereby the fund itself has gone up (we hope), but you now have extra units of the fund. So next year your fund will get dividends on the original units you owned, but also on the new ones you just recieved. Which will in turn be used to buy you more units next year.
And the shares go up, and cash rolls in, and you get more units…
And so on, and so on…..
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