EARNINGS ON STOCK INVESTMENTS

Stocks provide two different kinds of income: dividends and capital gains.

Capital gains are earnings generated by the sale of stock that has increased in value above its purchase price. Dividends are portions of company profits paid out regularly to investors.

In general, companies that are mature with low growth will provide bigger dividends than companies that are rapidly growing. Growth companies will plow their earnings into new business opportunities rather than distribute their earnings to shareholders. Investors who have a larger tolerance for risk and can wait longer to receive their income may opt for high-growth firms that do not pay out dividends, but whose stock price has tremendous upside potential. Some investors who prefer income sooner rather than later will opt for well-established, low-growth companies that pay out large annual dividends.

A stock's total return is composed of dividends and capital gains.

Let's take a look at a simple example. Suppose you bought a stock at the beginning of the year for $100. One year later, the company paid you a dividend of $2 and you sold the stock for $105. Your total return would be 7 percent.

Suppose you bought an Internet stock for $100 that pays no dividend while you hold the stock, but you sell it one year later for $110. Your total return would be 10 percent.

With stocks, dividends and capital gains work together to provide you with your total return. What about earnings on bond investments? Let's look at how bonds provide income to investors.