With the FTSE 100, the FTSE 250, and the S&P 500 up over the last month, it’s tempting to take profits on dividend stocks. But for investors seeking passive income, I think that’s a really bad idea.
Put simply, selling a number of dividend shares in May (in line with the old stock exchange adage) would mean not owning them on their ex-dividend date. An investor who does this would miss out on the shareholder payment later in the year.
Ex-dividend dates
As an investor looking to earn passive income, the point of focusing on dividend stocks is to receive a share of the company’s earnings as direct payments. But selling shares in May (or any other time) gets in the way of this.
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In order to earn dividend income, an investor has to be eligible to receive the payment. This involves owning the stock on the ex-dividend date.
For a number of companies, that date is in May. So an investor who sells shares at the start of the month might well miss out on passive income payments.
Tesco shares
Tesco is an example of a stock with an ex-dividend date in May. The company is set to distribute a dividend of 7.05p per share in June, which amounts to a 2.5% return on an investment made at today’s prices.
The ex-dividend date is 11 May. So in order to receive the dividend in June, an investor would have to own the stock at the start of that trading day.
Selling Tesco shares at the start of the trading day with a view to buying them again in October would mean missing out on a potentially significant payment. So clearly, selling is a bad idea for passive income investors.
Passive income
It’s not just Tesco, either. Other popular dividend stocks in both the UK and the US have ex-dividend dates in May.
Unilever for example, goes ex-dividend on 18 May. And investors who sell shares in Bunzl, Kraft Heinz or Visa will miss out on dividend payments later in the year.
Investors looking to earn passive income by receiving dividends should therefore think very carefully before selling. Doing so might interrupt their income stream.
Buying and selling
In theory, the risk of missing dividend payments might be offset by the opportunity to buy the shares again at a later date. But I don’t think this is a good reason to sell a stock.
The price of a company’s shares might well drop on their ex-dividend date. In the case of Tesco, the stock is worth more when it comes with a 7.05p payout than when it doesn’t.
This isn’t guaranteed, though – a lot can happen in the stock market and share prices are notoriously difficult to predict. An investor could sell only to find the share price rising.
How to invest
Ultimately, the best way to invest for passive income is by following Warren Buffett’s example. Buy shares in strong companies at good prices and then wait for the payments to roll in.
Doing this allows investors to benefit from the cash generated by the underlying business over a sustained period of time. Those who don’t plan on selling their shares can leave share price fluctuations for others to worry about.
