Updated July 14, 2023
Definition of Homemade Dividends
Homemade dividends are nothing but the type of investment income, or the proceeds of sale which the shareholder gets from the sale of part of his investment portfolio, i.e. the homemade dividends are the part of investment income of the shareholders that differs from other types of traditional dividends the shareholder gets from the company in which the board of directors of the company or the management has to approve the dividend distribution.
Explanation
The shareholder of the company sells some part of his investment to increase the cash inflow. There can be different objectives the person can have. Hence, to fulfill those cash flow objectives, the shareholder sells part of his investment, and the proceeds he gets from this sale of investment are called homemade dividends.
Features of Homemade Dividend
Features of Homemade dividend are:
- Unlike the other forms of dividends in which the company distributes the amount of profit to the shareholders, in homemade dividends, the amount of profit does not belong to the company. Still, it is part of a sale of the investment portfolio by the shareholder himself.
- Unlike the dividend policies followed and issued by the company, homemade dividends do not require a dividend policy as the investor decides on the dividends.
- In homemade dividends, the investor is not obligated to follow a particular pattern. It is completely at the investor’s discretion how much homemade dividend he can make by selling some portion of his investment.
Examples of Homemade Dividends
Let us take the example of company XYZ Ltd. XYZ Ltd declaring the dividend at some specific percentage.
Peter holds 1,000 shares of XYZ Ltd at $40 per share. XYZ Ltd paid a dividend of $2.5 per share. Peter was hoping to get a dividend of $3,500 with a rate of $3.5 per share. However, as the rate of dividend declared by XYZ Ltd is less than expectations of Peter, he is disappointed with the company’s cash inflows in the form of dividends. The company declared that the share price would fall to $25 per share after the ex-dividend date. Hence, Peter waits until the ex-dividend date, and the share price gets reduced, i.e., @25 per share.
Solution:
After the ex-dividend, Peter sells 40 company shares at the reduced price of $25.
Homemade Dividend is calculated as:
- Homemade Dividend = 40 * $25
- Homemade Dividend = $100
|
Particular |
Value |
| No. of shares held by Peter (A) | 1000 |
| Share Price per Share (B) | $40 |
| Dividend paid by the company per share (C) | $2.50 |
| Normal Dividend (D) = (C) *(A) | $2,500 |
| Peter’s expected dividend per share (E) | $3.50 |
| Peter’s expected cash inflows (F) | $3,500 |
| No.of shares sold by Peter (G) | 40 |
| Price per share (H) | $25 |
| Homemade dividend earned by peter (I) = (G) *(H) | $1,000 |
Benefits of Home Made Dividends
We give below some of the benefits:
- The shareholder can get the homemade dividend at any time at his discretion. He need not wait for the company’s declaration and receipt of the dividend.
- The cash inflow of the investor increases. Hence, he can undergo the planned activities and usage of homemade dividends for his personal or business purpose or any future purpose without any complexity.
- Also, he is under no control over selling a particular amount of shares or earning any specific amount of homemade dividend. He owns the shares, and hence it is completely his will what he makes from his shares and how much homemade dividend he gets.
Challenges of Home Made Dividend Policy
The following are the challenges of the homemade dividend policy:
- The sale of a fractional number of shares is not allowed. If the shareholder wants only a few amounts, he can sell 0.5 shares. He can’t sell the fractional number. He has to make the sale of 1 share, in which case he has to sell extra 0.5 shares. Of this, the number of shares will not remain to the shareholders for the future.
- The shareholder cannot sell the share directly in the market. He has to make the sell-through broker, in which case he has to bear brokerage expenses too. Hence, the dividend he expected through the sale of shares will be reduced by incurring brokerage expenses.
- The traditional dividends we get from the company generally have fewer taxes imposed on them. However, the taxes imposed on homemade dividends are more than those on traditional dividends because the homemade dividends are called the personal earnings of the shareholder.
- The homemade dividends are earned by the sale of investments by the shareholder. Hence the investment of the shareholder gets reduced. The return the shareholder was expecting from such an investment gets lost, and the shareholder faces a loss on the return in the future.
Conclusion – Homemade Dividends
A homemade dividend is one of the important and popular forms of income generation by selling part of the shareholder’s investment portfolio. Shareholders earn homemade dividends or make partial sales of their investments to meet their cash inflow expectations in case the company is unable to pay the desired dividend or meet the shareholder’s expectations. Sometimes, homemade dividends benefit the shareholder as he can generate income by selling investments whenever he wants. He can meet his cash inflow plans anytime. However, considering the sale cost of investments like brokerage cost, earning homemade dividends results in extra costs with less income. Also, the number of shares decreases in the future, again affecting the returned income for the future period. Considering all the above points, the shareholder should earn homemade dividends by selling part of his investments.
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