Dividends

A payment made by a corporation to its shareholders is known as a dividend¹. These payments are typically generated through a company's profits. They're essentially a way companies share their success with you, the investor.

What is a dividend?

A dividend is a portion of a company's earnings that is paid out to its shareholders. When you own stock in a company, you own a piece of that business, and dividends are your share of its financial success. Companies usually generate these payments directly from their profits after covering their operating expenses and reinvesting in their business. 

Dividends are often paid out on a regular schedule, commonly quarterly or annually, though some companies may pay monthly or semiannually. This steady income stream is a key component of total returns for many long-term investors.

How do dividends relate to your 401(k)?

Dividends can play a significant role in the growth of your 401(k) if your retirement investments include stocks or stock-based mutual funds.

• If the mutual funds or exchange-traded funds (ETFs) within your 401(k) hold dividend-paying stocks, those dividends are generally passed on to the fund and subsequently, to you as a fund shareholder.

• For most investments in a 401(k) plan, the dividend is automatically reinvested or used to purchase additional shares of the same fund or stock.

• Reinvesting dividends can be a powerful strategy for accelerating the growth of your retirement savings through compounding. By buying more shares, you own a larger piece of the investment, and those new shares can then earn their own dividends, creating a snowball effect over time.

Why do dividends matter for your 401(k) growth?

Dividends can be critical for investors focused on long-term wealth accumulation for two main reasons:

• Total return: Dividends contribute significantly to your total investment return. This return comes from two sources: the appreciation (or growth) in the price of your fund's shares, and the dividends paid by the stocks held within the fund. Over long periods, reinvested dividends can make up a substantial portion of an investment's total gains.

• Fuel for compounding: As mentioned, the automatic reinvestment of dividends is a key driver of compounding. This strategy allows the potential for your investment to grow exponentially over time as the dividend income is immediately put back to work, increasing the number of shares you own, which in turn can generate even more growth and future dividends. This makes them a fundamental component of any successful long-term investment strategy.

1. Investing involves risk, including risk of loss. Past performance does not guarantee future results. Dividends are not guaranteed.