We all like free money, right?
I know I sure do, which is why I immediately became interested in a strategy called dividend capturing. It works something like this.
You find a stock that pays a very generous dividend. Right before that dividend gets paid, you buy some shares. The stock pays the dividend, and most of the time, shares tend to recover to at least the same level as before. After paying commissions–which are basically nothing these days–an investor is left with the profit from the dividend.
Here’s a real life example, something that just happened. Cominar Real Estate Investment Trust (TSX:CUF.UN) has a monthly dividend of 12.25 cents per month for each share. At the end of each month, the company declares a dividend to be payable on the 15th of the following month. This declaration is announced well in advance.
Because stock trades take three days to settle, you can’t just go on the last day of the month and buy up shares. You have to get in on (or before) the ex-dividend date, which is two business days before the dividend declaration date.
Getting back to Cominar, this means you would have to buy your shares on April 27th to get the dividend which was declared on April 29th.
On April 27th, Cominar shares traded at a range of between $17.20 per share and $17.34, closing at $17.33. Say you split the difference, and got in at $17.27.
On April 29th, Cominar shares spent the day in a range between $17.20 and $17.30 per share. Let’s say you got lucky, selling your shares at $17.30.
In total, you’d have a profit of $0.1525 per share, less any commissions. You would have made $0.03 per share in capital gains, and $0.1225 per share in dividends. 15 cents per share doesn’t sound like much, especially after commissions, but getting a 0.8% return in two days translates into close to 160% annualized.
Unfortunately, life isn’t quite that easy. Here’s why a dividend capturing strategy is difficult to pull off.
Pennies in front of a steamroller
The big issue when it comes to dividend capturing is the upside potential versus the downside.
Again, let’s go back to Cominar as our real-life example. If you wouldn’t have sold out on April 29th for a slight profit, it look more than a week for shares to get back to the point where you were making money on this move. Yes, shares did get back to that range, but human psychology is a powerful thing.
Dividend capturing is supposed to be a quick strategy. You get in, collect the dividend, and then get out, making a slight profit. All it would take is for Cominar shares to fall $0.13 each–less than 1% of its market price–for the strategy to turn from a guaranteed money maker into a loser.
Essentially, the strategy turns into something akin to trying to pick up pennies in front of a steamroller. Sure, most of the time you’ll get your pennies. But when things go badly, they’ll go really badly.
Are ETFs a better solution?
There are certain investors who swear by an alternate dividend capturing method. It goes a little something like this.
At the end of the year, many ETFs pay out accumulated dividends in one lump sum. Depending on the ETF, that can be a windfall of anywhere from 2% to 5% of the value of the fund.
Let’s look at one I personally own, the Market Vector Russia ETF Trust (NYSE:RSX), an ETF which tracks the biggest companies with significant exposure to Russia.
This ETF collects dividends from these companies throughout the year and then pays them out right before the year ends. In 2015, this payout was $0.519 per share, which worked out to a yield of 3.6%.
Rather than try to trade in and immediately out of this stock, an alternative strategy would be to buy it as a longer-term investment right before the ex-dividend date. You’d get a nice 3.6% boost without having to do anything. And since it’s a long-term hold, you wouldn’t have to worry about short-term price movements. It’s a small move that won’t make you rich, but it will slightly boost returns.
Dividend capturing isn’t a great strategy. Sure, it can work, but for me, it’s just too much effort for the small reward. If I had $10 million to invest maybe things would be different, but at this point I can’t recommend it as a viable strategy for regular folks. It’s better to stick to the same boring principles everyone else says.