Homemade Dividends
Candlefocus EditorHomemade dividends are similar to writing covered call options, where an investor sells a call option on a security they already own. When they write the call option, they collect a premium which equates to a homemade dividend. In the same way, a homemade dividend can also result when an investor sells a portion of a stock or mutual fund that they own. Instead of reinvesting the profits from the sale, the investor uses the income for living expenses.
The strategy of homemade dividends is appealing to many investors for its flexibility. Unlike traditional dividend payments, which are fixed and predetermined, the amount of the homemade dividend is in-line with the portfolio’s performance. In addition, the investor can choose when to generate income from the portfolio. If a situation arises where additional funds are needed, the investor can decide when to generate the extra income from his portfolio.
In contrast to traditional income, harvesting a homemade dividend can result in taxable capital gains. After the partial sale of a stock or mutual fund, the investor is left with a smaller position than before and a taxable realized gain.
Some argue that harvesting homemade dividends isn’t always suitable for a long-term investment strategy. By taking away a portion of an investor’s portfolio, they are removing a potential growth opportunity. This can limit their future gains since the investor has a smaller position in the underlying asset, and the potential to grow their portfolio is reduced.
Overall, homemade dividends can be utilized to generate additional income while maintaining the flexibility to choose when to take the money out of the portfolio. However, investors should weigh the benefits and drawbacks of harvesting homemade dividend as it can expose investors to taxable capital gains, and also limit the upside potential on holdings.