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Capital gain distributions and dividends can be a source of income. But what’s the difference between a capital gain distribution and vs. dividend?
Well, they’re two different ways that companies pay out shareholder earnings. A capital gain distribution is earned on stocks you hold in your portfolio, while dividends are paid out on stocks you own.
What is capital gain distribution?
Capital gains are the difference between the purchase price of a security and its sale price. The sale price can be higher than what you paid for investment if its value has increased over time, allowing you to make money from selling it (or sometimes just holding onto it).
Like dividends, capital gains are taxed at different rates depending on how long you’ve held onto an investment before selling it: short-term capital gains are taxed as ordinary income; long-term capital gains enjoy preferential tax treatment and are generally taxed at 15%.
What is a dividend?
Dividends are a distribution of profits to shareholders. Dividend distributions are taxed at the corporate level and shareholder levels when the company pays out its earnings to investors.
This causes double taxation. When you receive dividends, you must pay tax on them as ordinary income in addition to any capital gains from selling or exchanging shares held for less than one year (long-term capital gains).
Capital Gains vs. Dividend Income: The Differences
The difference between capital gains and dividend income is that the former represents a return on investment. At the same time, the latter is a payment received from an entity or company.
If you buy a stock, for example, and its value increases over time, that represents capital gain. If you invest in a mutual fund and the value of your investment increases, that also means capital gain.
If you invest in a company through its stock and pay dividends to investors at some point during the year, you receive dividend income.
Dividends can be delivered to shareholders as cash payments or as shares of stock. These are just two examples of how dividend income can be earned.
Capital gains are calculated by taking the current value of an asset (minus any expenses incurred in its acquisition) and subtracting its purchase price.
In this context, “current” refers to when you sold it, and “purchase price” refers to what you paid. When calculating your capital gain, the cost basis of an asset is generally what you paid for it plus any costs related to acquiring that asset.
For example, if you bought shares of stock for $100 each and then sold them for $200 each, your capital gain would be $100 per share minus $100 per share for a total capital gain of $0 ($200 – $200).
Shareholders typically receive dividend income in proportion to their ownership stake in a company.
This amount can vary based on the company’s profitability or other factors such as how much money they have in reserves or how many outstanding shares they have issued; however, it typically varies anywhere from 1% up to 10% annually depending on these different factors affecting a company’s ability to pay out higher dividends.
| Dividends | Capital gains | |
| Meaning | Dividends are a distribution of profits to shareholders. Shareholders typically receive dividend income in proportion to their ownership stake in a company. | Capital gains are the difference between the purchase price of a security and its sale price. The sale price can be higher than what you paid for the investment if its value has increased over time, allowing you to make money from selling it |
| Frequency of profit | Only once when the share is sold and liquidized. | This could be quarterly or half-yearly, depending on the company. |
| Taxes levied | Low tax | High tax |
| Investment | Smaller investment compared to capital gains | A relatively higher upfront investment |
| What depends on? | It depends on the profit of the company and the decisions of leaders and the management. | It depends on the economic factors and influences that can tip the market and cause fluctuations. |
Dividends vs. Capital Gains Which is Better?
The choice between dividends and capital gains is often a matter of preference. If you’re looking for the highest return, it’s best to focus on both income sources. Dividends pay out regularly, but the company’s earnings per share limit their amounts. Capital gains offer large one-time payouts that can be more lucrative than other types of income if your timing is right.
1. If you’re looking for steady income, then dividends may be right.
You’ll receive them every quarter or year depending on how often your company distributes them (and some companies don’t pay dividends at all). Dividend payments typically increase as long as the company remains profitable, so this could be a good choice if you want a consistent source of income over time.
2. If you’re looking for a quick return on your investment, then capital gains may be the better option for you.
Capital gains are more volatile than dividends because they’re dependent on market conditions and investor behavior.
3. If you’re an individual investor
The answer is simple: dividends are better. That’s because you’ll pay less tax when you receive them. Capital gains are taxed at a higher rate than dividends, so if you’re in the 25% tax bracket and receive $100 in capital gains, that $100 will cost you $25 in taxes (before accounting for any deductions).
However, if you receive $100 from your company as a dividend, that $100 will cost you only $20 in taxes (again, before accounting for any deductions). So if you’re an individual investor who wants to keep more of your money after taxes are taken out, dividends are the way to go!
4. As a Business owner
However, if you’re looking at this as a business owner investing other people’s money—such as pension funds or mutual funds—your answer might be different: it depends on what kind of investment vehicle they’re using.
For example, if they invest through an index fund that only holds stock in companies that pay dividends,
Final thoughts
The bottom line is that both dividends and capital gains are income sources, but they’re very different.
Dividends are paid in cash from profits earned by a company, while capital gains are what you make when you sell assets for more than their purchase price.
While both types of income may be subject to taxes, there are exceptions to this rule. You should consult your financial advisor before deciding which type of investment strategy is right for you.
