Difference between Interest and Dividend
Updated: Mar 13
What Is Interest?
Interest is the cost of using somebody else’s money. When you borrow money, you pay interest. When you lend money, you earn interest.
How Do I Earn Interest?
You earn interest when you lend money or deposit funds into an interest-bearing bank account such as a savings account or a certificate of deposit (CD). Banks do the lending for you: They use your money to offer loans to other customers and make other investments, and they pass a portion of that revenue to you in the form of interest.
Periodically, (every month or quarter, for example) the bank pays interest on your savings. You’ll see a transaction in the interest payment, and you’ll notice that your account balance increases. You can either spend that money or keep it in the account so it continues to earn interest. Your savings can really build momentum when you leave the interest in your account; you’ll earn interest on your original deposit as well as the interest added to your account.
Earning interest on top of the interest you earned previously is known as compound interest.
Example: You deposit $1,000 in a savings account that pays a 5% interest rate. With simple interest, you’d earn $50 over one year. To calculate:
Multiply $1,000 in savings by 5% interest.
$1,000 x .05 = $50 in earnings (see how to convert percentages and decimals).
Account balance after one year = $1,050.
However, most banks calculate your interest earnings every day, not just over one year. This works out in your favor because you take advantage of compounding.
What Is Dividend ?
Dividend is sharing of profit of a company with its shareholders.
A shareholder, typically, gets two types of return from investment into shares: capital appreciation and dividend. A dividend is a portion of a company’s profits paid out to the company’s shareholders. When a company makes a profit, it can choose to reinvest that profit back into the business, but sometimes it pays a percentage of it back out to shareholders. Not every company pays dividends, but those that do often have slow, reliable growth.
Do all companies pay dividends?
Not all companies pay dividends. Newer industries, like tech startups, often choose only to reinvest their profits into the company. They are usually growing faster than more established companies, and their stock price might fluctuate with greater volatility. There’s little incentive to pay out dividends when the stocks themselves may offer more value and when it’s more strategic to invest as much of the profits back into the business as possible.
The value of a dividend is usually announced by the company as a rupee amount or as percentage of the price of each share, which is called a dividend yield. Let’s say a company announces a special dividend payment of 1.5% per share. If the stock is worth Rs100 per share, and you own 100 shares, you stand to earn Rs150. Sometimes a company may pay the dividend in more shares of the stock, which could potentially be more valuable.
Dividend Yield Formula
To calculate dividend yield, all you have to do is divide the annual dividends paid per share by the price per share.
Dividend Yield = Annual Dividends Paid Per Share / Price Per Share
For example, if a company paid out Rs. 5 in dividends per share and its shares currently cost Rs. 150, its dividend yield would be 3.33%.
Why Is Dividend Yield Important?
The primary reason to understand dividend yield is to help you understand which stocks offer you the highest return on your dividend investing money. But there are a few other benefits to consider.
Dividend Yields Make It Easy to Compare Stocks
If you’re an income investor, you’ll want to compare and select stocks based on which pay you the highest dividend per Rupee you invest.
For example, Companies A and B both pay an annual dividend of Rs.2 dividend per share. Company A’s stock is priced at Rs.50 per share, however, while Company B’s stock is priced at Rs.100 per share. Company A’s dividend yield is 4%, while Company Bs yield is only 2%, meaning Company A could be a better bet for an income investor.
Increasing Dividend Yields Indicate Financial Health
If a company chooses to raise its dividend—and therefore raise its dividend yield—this generally tells investors that the company is doing well since it can afford to pay out more of its profits to shareholders.
Generally speaking, older, more mature companies in settled industries tend to pay regular dividends and offer better dividend yields. Meanwhile, younger, faster-growing companies tend to reinvest their profits for growth instead of paying out a dividend.
Dividends Boost Your Returns
When you reinvest your dividends, instead of cashing them out every year or quarter, your investment benefits from compounding. Over time, compounding effects can drastically enhance your returns.
Risk of high dividend yield
A high dividend yield isn’t always a positive sign. In fact, an unexpectedly high yield could actually be a red flag. This might happen for a couple of reasons:
The company’s stock price has recently plummeted. If a stock has seen a dramatic price decline and its dividend hasn’t been cut yet, the yield can appear high. Consider a company that pays a Rs.2 annual dividend per share with a stock price of Rs. 60. If its price falls to Rs.20, its dividend yield almost triples to about 10%. This yield might look really favorable at first glance, but on deeper examination it actually signals that the company is in trouble because its share price has dropped sharply. This means that a dividend reduction or elimination may follow soon.
The company is attempting to woo investors with a high dividend payment. Some companies try to give their stock prices a boost by increasing the dividend to attract new investors. Impressed by the high dividend yield, some investors may buy shares, driving up the stock price. But this dividend payout—and increased stock value—may not last if the company isn’t financially stable and can’t afford to maintain the higher dividend payments.
With that in mind, it can make sense to look for companies with lower, but consistent, div
idend yields or to carefully invest only in high-dividend stocks that have solid financials and pay rates similar to others in their industry.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. FinPrint Group is not liable for any decision arising out of the use of this information.