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One way to improve your investment returns is to invest in dividend paying stocks. Stocks that pay dividends provide you with capital appreciation, but they also include a dividend that you are paid. This dividend is a portion of a company's profits and is paid out to all shareholders. You can use the dividend as income, or you can reinvest the dividend to increase you holdings and see a larger dividend next time the company pays out.

When you invest in dividends, one of the terms you hear about is the ex-dividend date. Understanding this terminology is important as you make decisions about when to buy and sell dividend stocks.

The Importance of the Ex-Dividend Date

Because stocks are bought and sold every day, the shareholders don't remain the same. As a result, there are questions about who should get the dividend when shares are bought.

In order to cut back on the confusion, companies announce a record date for shares. This is the date on which you must own the stock in order to be paid dividends. If you don't own the shares by that date, you don't receive the dividend payout for that period of time.

One of the problems that arise with this process, though, is that it takes time for a stock transaction to clear. So, if you buy shares the day before the record date, the transaction might not clear in time for you to receive the dividend. In order to help ease this process a little bit, an ex-dividend date is announced.

In many cases, the ex-dividend date occurs two days before the record date. In order to be paid the dividend, you need to purchase your shares by the ex-dividend date. This makes paying attention to the ex-dividend date more important than the actual record date.

But what happens if the stock transaction still takes too long to clear? There are usually provisions that allow for this. If you purchase the shares by the ex-dividend date, but the transaction didn't clear, the seller will receive the dividend. However, as long as you bought by the ex-dividend date, the seller is supposed to pass the dividend payment on to you.

Interestingly, the dividend payment can affect the stock price. Before the market opens on the day of the ex-dividend (and after the close of the market the day before), good-until-canceled, stop limit, and stop orders are all automatically reduced to reflect the amount of the dividend paid. The exception is for those orders that are designated “do not reduce.” The reduction can mean a lower stock price at the open, although trading throughout the day can change the outcome.

If you are planning to buy dividend stocks, you need to understand the ex-dividend date. You need to make sure that your purchase takes place by the ex-dividend date if you are interested in receiving dividends during the first payout when you own the shares. Pay attention to company announcements so you know when the ex-dividend date is, and plan accordingly.

When you invest in dividends, understanding the ex-dividend date is important as you make decisions about when to buy and sell dividend stocks.

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