Investing in shares has long been considered one of the most effective ways to grow wealth over time. But for those new to the share market, a common question arises: how exactly do you make money from shares? The two primary ways are through dividends and capital growth. Both can significantly contribute to your financial position, but they work in different ways and carry different considerations. Just as important is understanding the implications of tax on shares in Australia, as this can affect the returns you actually pocket.
In this article, we’ll break down how dividends and capital growth work, the factors that influence each, and what investors need to know when building their portfolios.
Table of Contents
Dividends: A Regular Income Stream
Dividends are payments made by a company to its shareholders, usually drawn from profits. Not all companies pay dividends—some prefer to reinvest earnings back into the business—but for those that do, dividends can be a steady source of income.
For many Australian investors, dividends are particularly appealing because of the franking credit system. This tax incentive ensures that company profits distributed as dividends are not taxed twice—once at the corporate level and again at the shareholder level. Instead, the tax already paid by the company is passed on as a credit, which investors can use to offset their personal tax obligations.
For example, let’s say you hold shares in a large Australian bank. Each quarter, you may receive a dividend payment directly into your bank account. If the dividend is fully franked, the bank has already paid tax on that income, and you’ll receive a credit that reduces your personal tax liability. This makes dividends particularly attractive for retirees and income-focused investors who value reliability.
Capital Growth: Building Wealth Over Time
Capital growth, also known as capital gains, occurs when the value of your shares increases over time. If you buy shares for $10 each and sell them later for $15, the $5 profit per share is your capital gain. Unlike dividends, capital growth is not realised until you actually sell your shares.
The key to capital growth lies in choosing companies with strong prospects for expansion, innovation, and profitability. For instance, if you invested early in a growing technology company, you may have seen the share price rise significantly as the company expanded and demand for its products increased.
While capital growth can deliver substantial returns, it is inherently less predictable than dividends. Market conditions, global events, company performance, and investor sentiment all play a role in determining share prices. That said, investors who hold shares for the long term often benefit from the overall upward trend of the market, even if short-term fluctuations create volatility.
Balancing Dividends and Growth
One of the key decisions for investors is whether to focus on dividend-paying shares, growth shares, or a combination of both. The right choice depends on individual goals, risk tolerance, and time horizons.
- Dividend-focused investors often prioritise stability and income. Retirees or those seeking passive income streams may prefer companies with a long history of consistent dividend payouts.
- Growth-focused investors may prioritise younger or rapidly expanding companies that reinvest profits to fuel future growth rather than paying dividends. These investors are comfortable with more volatility in exchange for the possibility of higher long-term returns.
- Balanced portfolios often include both, ensuring steady income through dividends while also capturing potential wealth creation from capital growth.
The Impact of Taxes
When considering returns from shares, it’s important to remember that tax obligations play a significant role in shaping your final gains.
Dividends: Depending on your income bracket, the franking credits attached to dividends may reduce or even eliminate the amount of tax you owe on this income. In some cases, you may even receive a refund if the credits exceed your tax liability.
Capital gains: Profits from selling shares are subject to capital gains tax (CGT). In Australia, if you hold shares for more than 12 months, you may be eligible for a 50% discount on the capital gain, which can significantly reduce your tax bill.
Because of these rules, understanding your obligations around tax on shares in Australia is essential when planning your investment strategy. A well-managed approach can help maximise your after-tax returns.
Risks and Considerations
While dividends and capital growth can both be lucrative, it’s important to understand the risks associated with investing in shares:
- Market volatility: Share prices can rise and fall quickly due to economic changes, global events, or shifts in investor sentiment.
- Company risk: If a company underperforms, reduces dividends, or faces financial challenges, shareholders may see both their income and capital value decline.
- Timing risk: Selling too soon or too late can impact the gains you realise, particularly when chasing capital growth.
Mitigating these risks often comes down to diversification—spreading your investments across different sectors, industries, and asset classes to reduce exposure to any single company or event.
Reinvesting for Compound Growth
Another strategy many investors use to maximise returns is dividend reinvestment. Instead of taking cash payouts, investors can opt to reinvest dividends back into buying more shares. This approach compounds returns over time, as reinvested dividends themselves generate additional dividends and potential capital growth. For long-term investors, reinvesting dividends can significantly accelerate portfolio growth, particularly in strong, stable companies that regularly distribute profits.
Practical Example: Combining Both Approaches
Let’s imagine two investors:
Investor A focuses solely on dividend-paying shares. They receive quarterly income, which supports their lifestyle and helps them avoid selling shares to fund expenses.
Investor B focuses on high-growth companies with no dividends. Over time, their shares appreciate in value, and they realise gains only when they sell.
A third option, Investor C, blends the two strategies, holding both dividend-paying companies and growth-focused shares. This approach delivers some reliable income while still capturing long-term capital gains.
By comparing these examples, it becomes clear that dividends and capital growth can complement each other in building wealth.
Final Thoughts
Making money from shares typically comes down to dividends and capital growth, each offering distinct advantages. Dividends provide regular, potentially tax-advantaged income, while capital growth allows for significant wealth building over the long term. The best strategy depends on your personal goals, whether that’s creating steady income, maximising long-term growth, or striking a balance between the two.
Most importantly, don’t overlook the role of tax and risk management. By staying informed about how tax on shares in Australia works and maintaining a diversified portfolio, you can position yourself to make the most of your investments.
In the end, whether you’re chasing dividends, capital growth, or both, the share market remains a powerful vehicle for building financial security and achieving long-term wealth goals.
