Dividends are confusing. My guess is that many traders simply do not trade around dividend dates, do not understand dividend dates, or are under the faulty influence of many popular misconceptions about dividend dates. The following explanation will simplify the technical language of the rules that govern the dates and in the process clear up the popular misconceptions.

 

There are four dates related to the payment of a dividend. The four dates are:

     1.  Declaration Date - This is the date the company declares the dividend.

     2.  Record Date - This is the day a buyer of a stock becomes the registered owner; also called the Owner of Record. The buyer of a stock must be on the company's books as the Owner of Record to receive a normal dividend. The company itself sets this date. Because of the T+3 settlement rule, stock trades must be  settled in three business days, meaning that to be an Owner of Record, a buyer of the stock must buy the stock three business days before the record date. 

     3.  Payment Date - This is when the dividend payment will be made. It is also set by the company.

     4.  Ex-Dividend Date - This is the only date of the four that directly affects traders, as it determines when the right to a dividend is no longer transferred with the sale of a stock. It is ex-dividend date determines which trader (the buyer or the seller) gets the dividend.

Contrary to another common misperception, the ex-dividend date is not set by the company.  It is set by the stock exchange the company's stock is traded on. To understand why it is the stock exchange and not the company that sets the ex-dividend date we have to first understand the process. If a company declares Thursday, the 12th, as the record date, an investor would normally have to buy the stock on Monday, the 9th, to qualify for the dividend because of the T+3 rule, which states that stock transactions must settle in three business days. (Settle meaning the payment must be delivered to the seller and the security must be delivered to the buyer.) From Monday, the 9th, count three business days to the settlement date (which is also the record date). Tuesday, the 10th, is one day; Wednesday, the 11th, is two days; and Thursday, the 12th, is three days.

Since Monday is the last day to buy the stock and qualify for the dividend, the next business day, Tuesday, is therefore the ex-dividend date. (Ex-dividend  means without the dividend.)

If it's that simple, then why doesn't the company set the ex-dividend date? Because if the exchange is closed on any one of the three days immediately prior to the record date (in this example Monday, Tuesday, or Wednesday), then there are not three business days between Monday and the record date of Thursday. For example, if Monday is an exchange holiday, then the last day to buy the stock and qualify for the dividend would be the previous Friday, the 6th.

Only the exchanges can determine which days they are open, and therefore which days are business days (trading days) applicable to the determination of the ex-date in the case of normal distributions. That is why the exchange, not the company, sets the ex-dividend date.

The most reliable source for a dividend record date is the press release from the company itself announcing the declaration of the dividend. The press release will typically include the declaration date, the record date, and the payment date. Only rarely will it include the ex-dividend date, and when it does, it will have been established by the rules of the stock exchange, not arbitrarily by the company.

Knowing the record date, determining the ex-dividend date is usually straightforward. To determine the ex-dividend date, simply count back two business days from the record date. Once again using the previous example, the record date is Thursday, the 12th, so the ex-dividend date is Tuesday, the 10th. The last day to buy the stock and qualify for the dividend is Monday, the 9th, the ex-dividend date is Tuesday, the 10th, and the record date is Thursday, the 12th.

No matter what day the record date falls on, to receive the dividend you must purchase the stock before the close of trading on the day before the ex-dividend date. The trade then settles, meaning the payment is delivered in exchange for the securities, three business days later, on the record date, and you become the owner of record. Therefore, if you buy on the ex-dividend date, you won't get the dividend because the trade will not settle until one business day after the record date.  Remember, ex-dividend means without dividend.

*Conversely, if you sell either on or after the ex-dividend date, you will still receive the dividend because that transaction will not settle until after the record date.

Many investors wrongly believe you must hold the stock until the record date or payment date before selling in order to receive the dividend.  That is not true. It is the ex-dividend date that determines which investor, the buyer or the seller, receives the dividend. Note: The three day settlement period (T+3) does not apply to ex-dividend dates, as they are real-time dates - buy before the ex-date, you qualify for the dividend; buy on or after the ex-date, you don't qualify for the dividend.

Extended Hours Trading - Another area of confusion about dividend dates is how extended hours trading affect dividend rules. The answer to that question is a simple one: extended hours trading (both pre-market trading and after hours trading) does not affect dividend rules. The statement in the previous paragraph still applies: buy before the ex-date (no matter if in pre-market trading, regular hours trading or after hours trading) you qualify for the dividend; buy on or after the ex-date (whether in pre-market trading, regular hours trading, or after hours trading) you don't qualify for the dividend.

Dividends are Not Free Money - Another common misconception is that a dividend is free money. Many uninformed traders scramble to get into a stock before the ex-dividend date in the mistaken belief that they will somehow end up ahead for having done so. This is not true because on the ex-dividend date the previous day's closing price will be reduced by the amount of the dividend.* This is because the rights to the dividend are no longer transferred with the sale of the stock and since the payment of the dividend has reduced the net value of the company by the same amount, the net value of a share of stock is proportionally less.  For example, a stock that pays a dividend of fifty cents per quarter and trades at $10.00 on the last trade of the day before the ex-dividend date will then have that closing price adjusted down at the open the next trading day (the ex-dividend date) to $9.50.  The fifty cent dividend is no longer available to buyers on the ex-dividend date, so that amount is deducted from the stock's price.  Theoretically, and indeed commonly in practice, the stock will not open at exactly $9.50, because market forces may drive the price higher or lower, but in any case, the dividend-adjusted price of $9.50 will remain as the basis upon which the daily change is calculated.  If, for example, the opening price is $9.00, the daily change at that point will be down $.50.  Indeed the price is a full dollar less than the closing price of the previous day, but because of the adjustment for the dividend, in reality the value has changed only fifty cents.

In addition, at the open on the ex-dividend date, all open orders will be automatically adjusted down by the amount of the dividend unless they have been placed with a Do Not Reduce restriction.

So, buying a stock before the ex-dividend date simply to capitalize on the (false) idea that a dividend is free money is nothing more than a beginner's mistake.