Capital gains & dividends: two powerful engines of wealth

People do not invest for various reasons. Some think a lot of money is required. On the other hand, others simply do not understand how money is made in the stock market. In this article, we will introduce you to two powerful engines that propel stock market wealth. These are the same two engines that allow the rich to stay richer.

The two engines of investment wealth

There are two main ways to make money on your stock market investments: capital gains and dividends. For the sake of simplicity, we will just briefly introduce these two concepts. We will devote more detailed posts to each engine separately. Let's talk about capital gains.

What are capital gains?

In simple terms, a capital gain is the increase in value or price of an investment to a price higher than the initial purchase price. To put capital gains in perspective, let's suppose you buy 80 shares of mutual fund WXYZ at $10 per share for a total price of $800 (80 x 10). Two years later, the price of the fund has increased to $18 per share. You sell all your shares for $1440 (80 x 18). Your capital gain would then be $640 ($1440 - $800). Mutual funds and index funds generate capital gains based on the composition of stocks in their portfolio. 

What are dividends?

Dividends are a portion of earnings or profits that a company pays to shareholders of a stock, index fund or mutual fund. Not all companies pay dividends. Dividends are usually paid quarterly (every four months). Let's use the same fictitious mutual fund above to elucidate the concept of dividends. Let's say that mutual fund WXYZ pays $0.20 in dividends every quarter. The amount of dividend per year is $0.80 ($0.20 x 4 quarters) or $1.60 in 2 years. With 80 shares, your total dividend income is $128 ($1.60 x 80).

The bottom line

Capital gains and dividends are two ways investors make a return on their investments. To better illustrate how investors make money with capital gains and dividends, check out this 3-month investing experiment

Like this article? Please share and leave us your feedback in the comment section and help us improve and grow. Subscribe below to get our latest articles. Here are a few other articles you may find useful: How to invest your tax refund | How to earn free money as a micro investor | Myth debunked: you don't need a lot of money to start investing | How to invest $100 | How investors make money in the stock market | Cash is trash, not king. Invest it! | Stocks vs. index funds vs. ETFs: what's the difference?