Dividends vs. Capital Gains

Dividends vs. Capital Gains

Introduction

With the revolution and competition in the business world, investors are putting their money in business ventures they anticipate to be successful in the near future. On the other hand, companies are regularly innovating and developing the best business strategies to attract more investors. Companies are paying their investors in terms of dividends or capital gains. While dividends and capital gains represent profit to the investors, they are mostly different when it comes to taxation, the amount of investment, and control by the investors.

Dividends

Taxation

Dividends exist as ordinary or qualified dividends, but both are taxed differently. In most cases, companies pay their shareholders in the form of ordinary dividends, which are paid out from the earnings made by the company. Ordinary dividends to shareholders or investors are taxed as ordinary income. Qualified dividends are dividends that meet the criteria of being taxed as capital gains, and their tax rate may range from 20% to 1% depending on the tax bracket of the corporation (Iskandar 10). Generally, the tax for dividends is low. As a legal requirement, companies must report their dividend income and publish it for public review, and all dividends must be taxed.

Investment

Dividends require less investment in shares. Many publicly-traded companies may not have a minimum number of shares for their investors, but ideally, investors should consider starting with a minimum of 500 to 1000 US Dollars value of shares (Khan, Qurat, Shah & Attaullah 370). Investors may buy shares directly from the company from brokerage companies. When purchased through brokers, the investor must pay brokerage fee some commissions for the trade. When an investor purchases stock through the open-air market, they may be forced to open an account with the brokerage firm that may require a minimum deposit. The investment required to invest in shares is reasonable.

Control

Investors or shareholders do not have control of the dividends. Dividends are decided by the management of the corporation, which has control over the dividends.  The corporation’s management must ensure effectiveness and efficiency in the corporation, sound use of resources, regular auditing and financial reporting, and compliance with legal requirements to secure profits in the company, which ultimately results in payment of dividends to the shareholders (Adam, Albert & Johannes 2370).

Capital Gains

Taxation

Capital gains can be either long term or short term, and either way, they are taxed differently. Long term capital gains are accrued when the asset is invested for more than one year, while short term capital gains are earned when the asset is invested for a period less than a year. Hartzmark & David (2170), states that long term capital gains have lower taxes, which may be up to 20, while short-term capital gains are taxed as ordinary income, and their tax rate may even be up to 37%. Additionally, investors with adjusted gross income may incur an extra tax of 3.8% as net investment income tax on both short-term and long-term capital gains (Hartzmark & David 2171). Therefore, taxation for capital gains is higher.

Investment

Investing in capital gains requires a lot of investment in terms of finances. Investment in capital gains may include mutual funds or real estate. Identifying the right mutual fund to invest in by the investor may be difficult. For instance, investing in real estate may require a lot of finances, finance for buying the asset, cost of meeting legal requirements like the hiring of an attorney, or acquiring title deeds. Additionally, the investor of real estate may also be required to acquire legislation from the Environment Protection Agency, which might be expensive to acquire (Iskandar 11). The above costs are an indication that investing in capital gains is expensive. The higher the investment, the higher the capital gain.

Control

Investors in capital gains have control over their assets. Therefore, they can sell the asset when the cost is high to earn a higher capital gain. Similarly, investors can withhold their assets when prices are low to avoid incurring losses. Investors also have the authority to monitor the condition of the asset overtime to ensure that they are in a condition that can guarantee better returns (Adam, Albert & Johannes 2380).

Conclusion

In conclusion, it is important for investors to evaluate the taxation rate, level of investment, and control to decide whether to invest in capital gains or dividends. Despite the high taxation and investment in capital gains, the returns are also promising. In the business world, it never goes without saying that the higher the risk, the higher the return. Similarly, the higher the investment, the higher the returns.

Work Cited

Iskandar, Muda. “Perception of capital, profit, and dividends affect the stock purchase intention in Indonesia public company.” Junior Scientific Researcher 3.1 (2017): 9-18.

Khan, Naimat U., Qurat Ul Ain, Shah Jehan, and Attaullah Shah. “Impact of taxation on dividend policy: Evidence from Pakistan.” Research in international business and Finance 42 (2017): 365-375.

Adam, Klaus, Albert Marcet, and Johannes Beutel. “Stock price booms and expected capital gains.” American Economic Review 107.8 (2017): 2352-2408.

Hartzmark, Samuel M., and David H. Solomon. “The dividend disconnect.” The Journal of Finance 74.5 (2019): 2153-2199.