What is the point of a dividend?

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Pepper11
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What is the point of a dividend?

Post by Pepper11 » Sat Mar 19, 2016 2:24 pm

Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?

Dandy
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Re: What is the point of a dividend?

Post by Dandy » Sat Mar 19, 2016 2:31 pm

The fund invests in stocks and bonds that pay interest/dividends back to the fund. That income (actual and accrued) becomes part of the fund's NAV when earned. In order to avoid the fund being taxed on this income it has to pay substantially all of it to its shareholders in the form of mutual fund dividends. So the original income from stocks and bonds is only taxed once not twice.

Since the income is added to the fund's NAV when it pays a divided the NAV is reduced by that amount (ignoring market changes). If you choose to reinvest the dividend you will buy the fund at the lower price.

What most people don't realize is that the growth of the NAV in between dividend distributions is partly due to accrued dividends and that the benefit of the fund paying a dividend is that the fund avoids paying taxes on its investment income and therefore can pass more money on to its shareowners.

That is the point.

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Re: What is the point of a dividend?

Post by sport » Sat Mar 19, 2016 2:32 pm

Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
A company earns money. If they do not have a need to spend it, the owners of the company (stock owners) would like to have it paid to them. You could also ask "what is the point of owning a share of a company if I cannot also share in the profits?"

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Re: What is the point of a dividend?

Post by LadyGeek » Sat Mar 19, 2016 2:34 pm

The wiki has some background info: Dividend
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Re: What is the point of a dividend?

Post by abuss368 » Sat Mar 19, 2016 2:35 pm

Jack Bogle has provided many interviews on the importance of dividends.
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Re: What is the point of a dividend?

Post by Dimitri » Sat Mar 19, 2016 2:42 pm

This topic has (in my opinion) been pretty much beat to death on this forum. Here is a long thread - viewtopic.php?f=10&t=181343

The only argument for not paying a dividend is tax considerations. But that is from the perspective of a US taxpayer. Stocks are international. Not everyone pays tax on their dividend.

To quote Kevin O'Leary:

My mother Georgette gave me a lot of amazing advice during her lifetime, but the most valuable habit she ever instilled in me was her investment philosophy: never spend the principal, only the interest.

As far as she was concerned, a stock without a dividend was pure speculation.

http://www.businessinsider.com/shark-ta ... day-2015-8 (bold mine)

I like dividends for a variety of reasons. So do many other people.
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jrinvestor
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Re: What is the point of a dividend?

Post by jrinvestor » Sat Mar 19, 2016 2:53 pm

Dividends are how companies return profits to investors. If a company doesn't have profitable projects to invest in, it will either pay dividends to repurchase stock.

While dividends do make you pay taxes today (rather than being able to defer the taxes until you want to sell), this does not matter to every investor. For example, pension funds, 401k, IRAs, 529 accounts, etc. can all be exempt from taxes on dividends and capital gains. Also, people in the 15% bracket pay 0% on qualified dividends.

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Re: What is the point of a dividend?

Post by Castanea_d. » Sat Mar 19, 2016 3:10 pm

In the old days, the regular payment of dividends over a period of years was an indicator of a "solid" company. I don't have "The Intelligent Investor" in front of me, but Benjamin Graham included dividends as one characteristic of the kind of stock that a "defensive" investor should purchase.

Here is a summary of Graham's views on selecting value stocks:
http://www.cabot.net/investing-advice/b ... k-criteria
Criteria #7: Invest in companies that are currently paying dividends. Investing in undervalued companies requires waiting for other investors to discover the bargains you have already found. Sometimes your wait period will be long and tedious, but if the company pays a decent dividend, you can sit back and collect dividends while you wait patiently for your stock to go from undervalued to overvalued.
I don't think that this how Graham phrased it, but it is close enough.

More recently, some investors noted that a lot of dividend stocks and mutual funds that invested in them were paying a higher percentage than most investment-grade fixed income. Why not invest in something like the Vg Equity Income fund (VEIPX), which is currently yielding a bit over 3%, in place of bonds?

There are serious problems with that approach, which have doubtless been discussed here at Bogleheads, mostly that the share price of any equity mutual fund is going to be a lot more volatile than quality fixed-income of short to medium duration. The ongoing dividend payouts are far from certain, as well, a lot less certain than the income from a bond.

I am still a fan of dividend-paying stocks (and the Equity Income fund is one of my largest holdings for that reason). But a lot of people consider them old-fashioned. They do tend to be "old economy" businesses, solid and often a little boring.

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Re: What is the point of a dividend?

Post by cheese_breath » Sat Mar 19, 2016 3:52 pm

The individual investments in a fund pay dividends. The fund is required by law to pay out these dividends to the fund's shareholders. What you do with them is your choice, but the fund is required to pass them on to you.
The surest way to know the future is when it becomes the past.

Miriam2
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Re: What is the point of a dividend?

Post by Miriam2 » Sat Mar 19, 2016 4:03 pm

Here is another discussion about dividends, addressing your point about fund value going down with dividends:

"Why do we like dividends?"
viewtopic.php?f=10&t=151795

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Re: What is the point of a dividend?

Post by Toons » Sat Mar 19, 2016 4:05 pm

Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
I keep getting increasing dividends from Mcdonalds over the years accompanied by increasing share price over time.
What gives??
They keep sending me money yet the value of the share holdings has soared the last 25 years.
Many years ago it dawned on me,,hey I don't have to sell shares,,they will just send me money quarterly.(increasing annually)
Is it supposed to work like that? :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

lack_ey
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Re: What is the point of a dividend?

Post by lack_ey » Sat Mar 19, 2016 4:27 pm

Are you asking why stocks return capital to investors or why they do that in the form of dividends specifically (as opposed to buybacks)?

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Re: What is the point of a dividend?

Post by Toons » Sat Mar 19, 2016 4:38 pm

lack_ey wrote:Are you asking why stocks return capital to investors or why they do that in the form of dividends specifically (as opposed to buybacks)?
Yes,
They return increasing capital to me in the form of dividends over the last 25 years.
Increasing every year.
Over time the share price also increases.
Average annual return is around 10.53% per year including
"return of capital' combined with increasing share price.
Would I be better served if they bought back shares
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: What is the point of a dividend?

Post by midareff » Sat Mar 19, 2016 4:39 pm

A dividend is a portion of the total return made up of dividends and capital appreciation. I'm retired and take my dividends in taxable and spend them on necessary things such as EFTPS, property taxes, car and condo insurance and such. The point of a dividend is it is part of your total return.

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Re: What is the point of a dividend?

Post by Toons » Sat Mar 19, 2016 4:41 pm

midareff wrote:A dividend is a portion of the total return made up of dividends and capital appreciation. I'm retired and take my dividends in taxable and spend them on necessary things such as EFTPS, property taxes, car and condo insurance and such. The point of a dividend is it is part of your total return.
+1
That is similar to what I do with dividends from mutual funds ,,,stocks,,in taxable account.
Spend where I want to as I am also retired.
I don't have to think about selling shares.
The money comes in every quarter.
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: What is the point of a dividend?

Post by Dirghatamas » Sat Mar 19, 2016 5:04 pm

Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
You are not missing anything. I share your frustration. I just finished doing my taxes this weekend and after a tremendous amount of effort in deferring compensation, got my taxes (federal + state) down to about 32X my yearly expenses compared with >40X last year. I would love my taxes to go down to 10X my expenses or (one can hope) even 1X my expenses. Dividends are a terrible, terrible waste of one's hard earned money by paying unnecessary taxes during accumulation phase. They make my blood boil but you can't fix people's irratonality. :annoyed

Sane capitalists like Buffett have it right as they have never paid dividends. Unfortunately, there is nothing you can do about dividends because they are a legacy of a bygone era when buybacks/stock sales were expensive and buybacks were even quasi illegal (in the modern extensive sense of buyback usage to return cash to shareholders). Further, a lot of people pay hardly any taxes so for them, they like dividends. If someone's taxes are less than their expenses, then it (dividends vs. buybacks) is probably just noise to them and dividends are simpler. They don't care that others have to pay an arm and a leg due to dividends. There exist no diversified funds that can mimic the broad market index funds but eliminate dividends (instead do buybacks). You are stuck with people's irrationality so just hold your nose and invest in broad market index funds knowing fully well the pitfalls and irrationality of dividends. That's what I do :annoyed

And no, nothing above was written tongue in cheek. I really am annoyed at how hard it is to accumulate for retirement with constant tax drags like dividends.

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Re: What is the point of a dividend?

Post by Geologist » Sat Mar 19, 2016 5:07 pm

Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
It seems to me the OP is not asking about dividends in general, but mutual fund dividends in particular. Cheese_breath certainly gave part of the answer: it is required by law. The additional information is that it is required by law if the mutual fund is to avoid owing corporate income taxes. That way the fund shareholders only have to pay taxes on their receipt of the dividends and realized capital gains and the fund need not pay any federal income taxes. The fund could choose not to pay out dividends and realized capital gains, but then would have to pay corporate income tax each year (recall that the base rate is 35%) and then the shareholder would also pay taxes when selling shares. For most people, this would be a higher total tax bill over time.

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Re: What is the point of a dividend?

Post by Dimitri » Sat Mar 19, 2016 5:08 pm

Dirghatamas wrote:
Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
You are not missing anything. I share your frustration. I just finished doing my taxes this weekend and after a tremendous amount of effort in deferring compensation, got my taxes (federal + state) down to about 32X my yearly expenses compared with >40X last year. I would love my taxes to go down to 10X my expenses or (one can hope) even 1X my expenses. Dividends are a terrible, terrible waste of one's hard earned money by paying unnecessary taxes during accumulation phase. They make my blood boil but you can't fix people's irratonality. :annoyed

Sane capitalists like Buffett have it right as they have never paid dividends. Unfortunately, there is nothing you can do about dividends because they are a legacy of a bygone era when buybacks/stock sales were expensive and buybacks were even quasi illegal (in the modern extensive sense of buyback usage to return cash to shareholders). Further, a lot of people pay hardly any taxes so for them, they like dividends. If someone's taxes are less than their expenses, then it (dividends vs. buybacks) is probably just noise to them and dividends are simpler. They don't care that others have to pay an arm and a leg due to dividends. There exist no diversified funds that can mimic the broad market index funds but eliminate dividends (instead do buybacks). You are stuck with people's irrationality so just hold your nose and invest in broad market index funds knowing fully well the pitfalls and irrationality of dividends. That's what I do :annoyed

And no, nothing above was written tongue in cheek. I really am annoyed at how hard it is to accumulate for retirement with constant tax drags like dividends.
Not much sympathy here. Your tax bill is 32x your annual expenses. Not doing too bad. You surely have a lot left over to invest. If you don't want to pay tax on dividends then you should buy stocks that don't pay dividends. Problem solved.
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Re: What is the point of a dividend?

Post by bhsince87 » Sat Mar 19, 2016 5:15 pm

In some ways, dividends are relics of the past. Before online stock trading became available, buying or selling stocks, bonds, and even most mutual funds could be a slow and expensive process. Regular dividend payments (and dividend reinvestment programs) made much more sense back then.

Even today, they are nice for folks who need regular income. Yes, in theory they could just sell shares, but there is often still a commission cost associated with that.
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Re: What is the point of a dividend?

Post by Dirghatamas » Sat Mar 19, 2016 5:17 pm

Dimitri wrote: Buy stocks that don't pay dividends. Problem solved.
Like I said in my post, there exist no broad market index funds (US or International) that provide the broad diversification AND avoid the tax drag of dividends. Yes, you can buy individual stocks like Buffett's Berkshire that don't pay dividends but then you are taking concentrated stock risk. I have also looked in detail into tax managed mutual funds but again they don't have similar diversification like broad market index funds.

This is not a case of six of one vs. half a dozen of the other. People who don't have to pay taxes shouldn't care about dividends vs. buybacks (it is mathematically the same). For people who DO have to pay a ton of taxes like me, the reverse is not true (dividends suck). So, it is an asymmetric situation. One side gains nothing by getting cash through dividends (instead of buybacks) while the tax payers end up paying through their nose, with much higher losses.

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Re: What is the point of a dividend?

Post by snarlyjack » Sat Mar 19, 2016 5:29 pm

I'm a young guy in the accumulation phase of my fund (VHDYX).
I DCA (dollar cost average) 12 times a year (monthly).
But I also get 4 quarterly dividend payments.
This makes for 16 DCA per year.
My fund is increasing (number of shares) pretty quickly.

That's not even counting the "growth" rate of the price per share!

Whenever I have extra money I invest in the fund. My dca is really
about 20 times per year. It's all about...Compounding...

Compounding is the 8th wonder of the world!

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Re: What is the point of a dividend?

Post by sweeneyastray » Sat Mar 19, 2016 5:32 pm

Dividends, or the possibility of dividends at some future point in time, are logically necessary for equities to have any fundamental value. If Google announced that it would never, ever pay dividends to its owners, and had a credible way of following through on that promise, then the rational value of Google stock would be zero.

Of course, if that were the case, the owners of Google stock would sue management for theft, etc. The thought experiment is to illustrate that the intrinsic value of a share of non-dividend-paying stock relies on some future buyer getting paid dividends in some form by the company. Otherwise it's all just "greater fool" theory until the last buyer is left holding a worthless share of stock (which certainly happens in real life).

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Re: What is the point of a dividend?

Post by Dimitri » Sat Mar 19, 2016 6:08 pm

Dirghatamas wrote:
Dimitri wrote: Buy stocks that don't pay dividends. Problem solved.
Like I said in my post, there exist no broad market index funds (US or International) that provide the broad diversification AND avoid the tax drag of dividends. Yes, you can buy individual stocks like Buffett's Berkshire that don't pay dividends but then you are taking concentrated stock risk. I have also looked in detail into tax managed mutual funds but again they don't have similar diversification like broad market index funds.

This is not a case of six of one vs. half a dozen of the other. People who don't have to pay taxes shouldn't care about dividends vs. buybacks (it is mathematically the same). For people who DO have to pay a ton of taxes like me, the reverse is not true (dividends suck). So, it is an asymmetric situation. One side gains nothing by getting cash through dividends (instead of buybacks) while the tax payers end up paying through their nose, with much higher losses.
I pay taxes. My house pays more in taxes than we spend. But I still like dividends. I don't want buybacks. I want cash in hand quarterly.

Why is there no broad market index fund that provides broad diversification and avoids the tax drag of dividends? Probably because it isn't marketable?

My suggestion? Go to Brown Brother Harriman - https://www.bbh.com/en-us/private-banking (or your preferred private banker) and request that they invest your funds as you wish. You won't have to deal with dividends.
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Re: What is the point of a dividend?

Post by cheese_breath » Sat Mar 19, 2016 6:49 pm

From a (simplified) investor perspective, other than dividends not being a fixed rate and there's no such thing as qualified / nonqualified interest, I don't see a lot of difference between the dividends I receive from my TSM fund and the interest I receive from my Ally Bank savings account. In both cases I'm credited with some amount of money which I pay taxes on whether I choose to take it out or reinvest it.
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Re: What is the point of a dividend?

Post by Coles » Sat Mar 19, 2016 7:10 pm

Dirghatamas wrote:One side gains nothing by getting cash through dividends (instead of buybacks)
There are agency costs to buybacks. Difficult to quantify, but very real.

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Re: What is the point of a dividend?

Post by TOJ » Sat Mar 19, 2016 7:16 pm

You get money to spend without permanently losing shares. It's pretty easy to see the draw. A temporary drop in NAV means nothing if you don't intend to sell the shares.

The shares pay rent to you. Think of it like real estate holdings. Do you want to sell a property for money or would you rather it pay rent to you into perpetuity?

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Re: What is the point of a dividend?

Post by bhsince87 » Sat Mar 19, 2016 7:20 pm

cheese_breath wrote: I don't see a lot of difference between the dividends I receive from my TSM fund and the interest I receive from my Ally Bank savings account. In both cases I'm credited with some amount of money which I pay taxes on whether I choose to take it out or reinvest it.

But on the dividends, you pay anywhere from 0 to 20% tax (assuming they're qualified). The interest from your savings account is taxed at your marginal rate. Depending on your income level, that will most likely be higher.
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Re: What is the point of a dividend?

Post by WasabiOsbourne » Sat Mar 19, 2016 7:35 pm

bhsince87 wrote:In some ways, dividends are relics of the past. Before online stock trading became available, buying or selling stocks, bonds, and even most mutual funds could be a slow and expensive process. Regular dividend payments (and dividend reinvestment programs) made much more sense back then.

Even today, they are nice for folks who need regular income. Yes, in theory they could just sell shares, but there is often still a commission cost associated with that.
i was going to add something like this... transaction costs back in the day.. dividends not really necesary with low T costs.

nd nowhere near everyone is with a discount broker these days (for lots of reasons... for instance, your son-in-law is a broker and his firm wants him to charge 1% on all trades, so there's $300 commish on $30K sale)........

instead, you have $1.5MM portfolio... you get $60K build up every year. you just ask him for the $$$$

the question as to why there's no big ETF with zero dividend is interesting.. not sure if it's true...... one thing is if your money manager is getting the dividend then you are liable for tax.. so your ETF manager might just have to roll contracts constantly but would that generate CG?.......

seems like you either own stocks, that generally pay dividends, or if not you might be liable for CG tax constantly...

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Re: What is the point of a dividend?

Post by cheese_breath » Sat Mar 19, 2016 8:52 pm

bhsince87 wrote:
cheese_breath wrote: I don't see a lot of difference between the dividends I receive from my TSM fund and the interest I receive from my Ally Bank savings account. In both cases I'm credited with some amount of money which I pay taxes on whether I choose to take it out or reinvest it.

But on the dividends, you pay anywhere from 0 to 20% tax (assuming they're qualified). The interest from your savings account is taxed at your marginal rate. Depending on your income level, that will most likely be higher.
Isn't that inferred from the first part of my post which you deleted? (no such thing as qualified / nonqualified interest)
cheese_breath wrote:From a (simplified) investor perspective, other than dividends not being a fixed rate and there's no such thing as qualified / nonqualified interest....
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Re: What is the point of a dividend?

Post by Oicuryy » Sat Mar 19, 2016 11:40 pm

A loophole in the tax laws allows investment companies (mutual funds) to avoid corporate income tax if they distribute "substantially all" of their income to shareholders each year. That is why mutual funds pay distributions.

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Re: What is the point of a dividend?

Post by HomerJ » Sat Mar 19, 2016 11:54 pm

Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
Originally, the whole point of part-ownership in a company was to share in it's profits.

Your brother-in-law owns a dry cleaning store. You buy 10% of it. You get 10% of the profits each quarter. Why would you buy 10% of his store and let him keep all the profits?

I think it's crazy that he's convinced you to let him expand the store, telling you that re-investing the money instead of paying it out will make the company worth more. So you say "Awesome! So profits will go up, and then someday I'll get even bigger checks?"

"No, no... I'll NEVER pay you a cent. But you can sell parts of your shares to other people who also will never get a single dime of profit, but they will own a part of a company that is paying ME big profits each year."

Really, I don't understand the modern stock market at all. The original reason to own 0.0001% of a company was to get 0.0001% of the profits.

I really don't understand the whole idea of "We will NEVER pay our investors anything. They can just calculate how much the company is worth based on complicated accounting reports combined with vague predictions of future earnings, combined with emotional mood swings of millions of investors, meanwhile we'll just give ourselves large bonuses in actual cash from the profits that apparently they don't want".
Last edited by HomerJ on Sun Mar 20, 2016 12:06 am, edited 1 time in total.

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Re: What is the point of a dividend?

Post by HomerJ » Sun Mar 20, 2016 12:04 am

Dirghatamas wrote:And no, nothing above was written tongue in cheek. I really am annoyed at how hard it is to accumulate for retirement with constant tax drags like dividends.
You have already accumulated enough for retirement. There's zero reason for you to continue working.

So it's been very easy for you to accumulate for retirement.

Dividend taxes have very little effect on most people's retirement plans. Total Stock Market Index Fund pays 2% dividends, at a tax rate of 15% or 20%. Even at 20%, that's 0.4% drag on your returns. And that drag is only on money in your taxable accounts.

For most of us, a large percentage of our money goes into tax-deferred accounts. So that 0.4% drag on your taxable investments might only translate to 0.2% or less drag on your entire portfolio (if 50% or more of your investments are in tax-deferred accounts like 401k or IRA)
Last edited by HomerJ on Sun Mar 20, 2016 10:16 am, edited 2 times in total.

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Re: What is the point of a dividend?

Post by whodidntante » Sun Mar 20, 2016 12:56 am

Once you pay a dividend, your shareholders expect it forever. They also expect it to increase, because growth is good and whatnot.

Buybacks are the new way that many American companies "return capital to shareholders." Buybacks increase EPS by reducing shares outstanding. Though some companies have buybacks for media purposes. They like to pay their employees with stock, then they get a share price bounce from announcing large stock buybacks. I own one such company. Though they also pay a big dividend. The joys of cash cashs.

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Re: What is the point of a dividend?

Post by dkturner » Sun Mar 20, 2016 6:23 am

Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
History suggests that investors favor dividend paying stocks over non-dividend payers, and are willing to pay higher prices for them. According to research done by Kenneth French (of Fama/French fame) dividend paying stocks have provided meaningfully higher total returns than non-dividend payers, and have done so with lower SD of returns. In theory this may make no sense, but in practice it has worked marvelously for investors. Being naive, I have always believed that when theory and practice diverge, it's usually better to favor practice.

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Re: What is the point of a dividend?

Post by Clive » Sun Mar 20, 2016 6:39 am

dkturner wrote:
Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
History suggests that investors favor dividend paying stocks over non-dividend payers, and are willing to pay higher prices for them. According to research done by Kenneth French (of Fama/French fame) dividend paying stocks have provided meaningfully higher total returns than non-dividend payers, and have done so with lower SD of returns. In theory this may make no sense, but in practice it has worked marvelously for investors. Being naive, I have always believed that when theory and practice diverge, it's usually better to favor practice.
Only when you compare Value Weighted (cap weighted). For equal weighted the difference is minimal (noise) with regard to total (annualised/geometric) reward. Non dividend however did exhibit considerably higher volatility in providing such comparable reward and hence a lower 'risk-adjusted' reward. Providing you can select start/end dates however rather than being forced to buy/sell at points in time, then interim volatility 'risk' can be ignored such that that risk is negated. If you time the start and end dates to buy when the higher volatility choice has swung low, sell when its swung high, then that higher 'risk' (volatility) can yield a risk-premium.

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David Jay
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Re: What is the point of a dividend?

Post by David Jay » Sun Mar 20, 2016 6:42 am

dkturner wrote: Being naive, I have always believed that when theory and practice diverge, it's usually better to favor practice.
In theory, theory and practice are the same. In practice, they are not.

:wink:
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

Clive
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Re: What is the point of a dividend?

Post by Clive » Sun Mar 20, 2016 7:03 am

Dirghatamas wrote:
Dimitri wrote: Buy stocks that don't pay dividends. Problem solved.
Like I said in my post, there exist no broad market index funds (US or International) that provide the broad diversification AND avoid the tax drag of dividends. Yes, you can buy individual stocks like Buffett's Berkshire that don't pay dividends but then you are taking concentrated stock risk. I have also looked in detail into tax managed mutual funds but again they don't have similar diversification like broad market index funds.

This is not a case of six of one vs. half a dozen of the other. People who don't have to pay taxes shouldn't care about dividends vs. buybacks (it is mathematically the same). For people who DO have to pay a ton of taxes like me, the reverse is not true (dividends suck). So, it is an asymmetric situation. One side gains nothing by getting cash through dividends (instead of buybacks) while the tax payers end up paying through their nose, with much higher losses.
Compare Kenneth French's equal weighted non-dividend data with the broader market http://mba.tuck.dartmouth.edu/pages/fac ... brary.html and historically the two have returned comparable geometric (annualised) reward, but non dividend did so with (much) greater volatility - i.e. higher Sharpe. The lower 'risk-adjusted' reward (greater volatility) for some might be acceptable given the lower costs in practice (dividend tax). Unfortunately of all the ETF's out there, non that I know of provide such a fund.

The diversification can be a issue, concentration into certain sectors. A ETF that diversified more evenly across sectors holding non dividend stocks would be a limited few stocks such that a ETF fund wouldn't cost-in - so you have to manage that yourself, but end up holding so few stocks that single stock risk is a concern. Selling the dividend (sell just prior to x-div, repurchase again later), is less practical in the US due to the policy of relatively frequent payment of dividends (quarterly or whatever rather than once/year), and will typically have the tax cost of the dividend (price difference between selling and repurchasing) reflect a 15% type dividend cost anyway. BRK is once choice, but that exposes you to single stock risk (reinsurance business)..... In short its a cost that benefits the taxman and 15% dividend tax (or whatever) on dividends (3% perhaps) = 0.45%/year overhead (historically higher).

Discount that cost in addition to trading costs, market makers spreads and inflation and historic net real (after costs/taxes) total returns are much lower than what published figures (salesmen pitch) indicate. Measure on net-real terms and the efficient frontier can be a totally different set of assets than what the salesmen pitched based figures indicate - subject to the tax efficiencies of the alternatives. Many capitalist states are introducing 'anti-avoidance' measures often on the pretext of closing down on 'illegal' activity - whereas the greater impact is more often upon perfectly legal activity. High inflation/interest rates/dividends combined with high (adjustable) taxation, applied to 'nominal gains' is a risk-factor that is often overlooked in the current low inflation era. That risk is amplified by the potential high cost of switching as-and-when that risk factor comes to fruition (either having to accept/realise capital gains taxation to switch, or stick with paying relatively high taxes).

For me, that risk was all too apparent and real. Accordingly my asset allocation reflects that risk. Instead of a more usual three-fund, its better for me personally to hold a more tax efficient variant of that comprised of tax efficient/exempt stock, own home and gold. Here in the UK your primary home is exempt from capital gains tax when sold, and the gross imputed rent benefit is tax exempt. Certain gold coins being legal tender are tax exempt. And there are methods to hold limited amounts of stock tax exempt. Have a look at the Portfolio Returns table in this link https://www.portfoliovisualizer.com/bac ... REIT1=33.3 and you'll see somewhat similar average, standard deviation, max drawdown, min ...etc. Whilst those figures I believe include costs (fund fees) they exclude tax costs and portfolio 1 has a much lower tax cost - at least for UK investors. Stock/equity (home with imputed rent considered) and gold barbell is a form of bond bullet, but one that is potentially the more tax efficient. Consider for instance in the UK mid 1970's/early 1980's when nominal interest rates were up at 15% type levels and basic rate (most common) taxpayers were paying 33% tax on those nominal gains (despite inflation also running at 15% or higher levels). A yearly 5% tax drag cost combined with other costs and perhaps income being drawn ... for a number of years in a row, and for some that was financially fatal.

Extending the land (home), business (stocks), reserves (gold) Talmud type portfolio data back historically and for UK over the last 100 years on average the best asset each year gained +16% inflation adjusted whilst the other remaining two assets on averaged lagged inflation by less than -1%. Profit taking a income (dividend) out of capital gains in the best performing asset each year could have provided a comparable dividend to 100% stock - whilst also paying for rebalancing costs in the process. In total returns the differences were of the order 5.5% (Talmud) versus 6.5% (100% stocks) - before taxes. 10.5% versus 11.5% nominal total returns. Subject to taxation the difference between those two could have narrowed right down, or possibly even be reversed i.e. perhaps something along the lines of a 20% dividend tax on a 5% average dividend (let along capital gains taxes on top as well).

fortyofforty
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Re: What is the point of a dividend?

Post by fortyofforty » Sun Mar 20, 2016 7:26 am

As stocks fall into the "value" camp, they are perceived as being more risky than other stocks. They are at greater risk of bankruptcy, of losing value, of collapsing, at least in perception. That is why it is widely believed they provide a higher return, in reward for assuming more risk. Many owners like to receive some money back in the form of dividends, to mitigate the risk of total loss. At least, even should the stock drop to zero, owners receiving dividends haven't realized no return at all. Owners of companies that pay no dividends are at risk of losing everything, such as with Enron or Global Crossing. Sometimes paying regular dividends forces a company's management to act responsibly in order to meet this obligation, and lends an air of stability in an inherently unstable asset.

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Re: What is the point of a dividend?

Post by Valuethinker » Sun Mar 20, 2016 7:50 am

Dirghatamas wrote:
Pepper11 wrote:Whats the point? You get your dividend money and your fund falls by an equivalent amount. Then you are taxed on your so called "earnings", when your net worth is unchanged. Can anyone explain why these things even exist. Just sell some of your fund if you want the cash. What am I missing here?
You are not missing anything. I share your frustration. I just finished doing my taxes this weekend and after a tremendous amount of effort in deferring compensation, got my taxes (federal + state) down to about 32X my yearly expenses compared with >40X last year. I would love my taxes to go down to 10X my expenses or (one can hope) even 1X my expenses. Dividends are a terrible, terrible waste of one's hard earned money by paying unnecessary taxes during accumulation phase. They make my blood boil but you can't fix people's irratonality. :annoyed

Sane capitalists like Buffett have it right as they have never paid dividends. Unfortunately, there is nothing you can do about dividends because they are a legacy of a bygone era when buybacks/stock sales were expensive and buybacks were even quasi illegal (in the modern extensive sense of buyback usage to return cash to shareholders). Further, a lot of people pay hardly any taxes so for them, they like dividends. If someone's taxes are less than their expenses, then it (dividends vs. buybacks) is probably just noise to them and dividends are simpler. They don't care that others have to pay an arm and a leg due to dividends. There exist no diversified funds that can mimic the broad market index funds but eliminate dividends (instead do buybacks). You are stuck with people's irrationality so just hold your nose and invest in broad market index funds knowing fully well the pitfalls and irrationality of dividends. That's what I do :annoyed

And no, nothing above was written tongue in cheek. I really am annoyed at how hard it is to accumulate for retirement with constant tax drags like dividends.
You are a little behind on your corporate finance theory.

Modern corporate finance theory recognizes that:

- there is a signalling content in dividends. It overcomes the asymmetric information problem between management and external shareholders. Because a dividend is in *cash* and cannot be manipulated (whereas profits can be) it is a signal of the quality of the underlying earnings for investors

- it helps to bridge the principal-agent problem - evidence is managements treat paying a stable dividend much like a fixed charge (ie a corporate loan or bond) -- it reduces their free cash flow (which they tend to waste) and serves as a capital allocation dividend within the business

- it is a credible signal. Companies announce buyback programmes and the impact on the stock price is less. The reason being they often don't fulfill the announced programmes, and there's not the same negative impact if they stop them that there is on cutting or cessation of a dividend. Although (in the absence of taxes: Modigliani & MIller axioms) theoretically a buyback and a dividend are identical, in reality a dividend (and especially a dividend increase or cut) has a stronger signalling effect due to its credibility with outside shareholders (who are less informed than the board about the prospects for the business)

- there may (or may not) be a clientele effect-- some investors prefer steady dividends. This has to do with behavioural financial biases, but by meeting such a bias, a company can get a higher stock valuation (good for all shareholders)

Balanced against this, now, is the concern that companies are overdistributing because of the fear of cutting their dividend leaving them open to takeover threats/ share price falls which hurt executive compensation.

The market has been chasing all forms of income, and has not necessarily been discriminating between interest and dividend income.

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Re: What is the point of a dividend?

Post by Valuethinker » Sun Mar 20, 2016 9:38 am

HomerJ wrote:
I really don't understand the whole idea of "We will NEVER pay our investors anything. They can just calculate how much the company is worth based on complicated accounting reports combined with vague predictions of future earnings, combined with emotional mood swings of millions of investors, meanwhile we'll just give ourselves large bonuses in actual cash from the profits that apparently they don't want".
You can synthesize your own dividend by selling a proportion of your holdings each period.

You solve a complex system of simultaneous differential equations twice a day: your drive to and from work. It does not involve a knowledge of physics and classical mechanics to drive a car.

In the same way, the market needs relatively few investors analyzing stocks and trying to identify fundamental value to keep those stock prices efficient, give or take some random noise.

The standard presumption in valuation theory, by the way, is that the company *will* eventually pay a dividend-- when its growth has reached a steady state around that of the market as a whole. If it does not, then either Private Equity will do a Leveraged Buy Out on it, or there will be a hostile M&A action (or activist corporate investor).

But when you run the Discounted Cash Flow on the stock, a big part is the terminal value, based on perpetual cash flows, which assumes either the business is sold at that point or that it distributes all Free Cash Flow to shareholders and bondholders.

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Re: What is the point of a dividend?

Post by Valuethinker » Sun Mar 20, 2016 9:41 am

Dirghatamas wrote:
Dimitri wrote: Buy stocks that don't pay dividends. Problem solved.
Like I said in my post, there exist no broad market index funds (US or International) that provide the broad diversification AND avoid the tax drag of dividends. Yes, you can buy individual stocks like Buffett's Berkshire that don't pay dividends but then you are taking concentrated stock risk. I have also looked in detail into tax managed mutual funds but again they don't have similar diversification like broad market index funds.

This is not a case of six of one vs. half a dozen of the other. People who don't have to pay taxes shouldn't care about dividends vs. buybacks (it is mathematically the same). For people who DO have to pay a ton of taxes like me, the reverse is not true (dividends suck). So, it is an asymmetric situation. One side gains nothing by getting cash through dividends (instead of buybacks) while the tax payers end up paying through their nose, with much higher losses.
These investors who don't pay tax?

Often Pension Funds-- who then pay pensions, which *are* taxed. Ditto insurance.

And of course university endowments use the money to pay people for projects, so again it gets taxed.

The problem is greater with offshore investors, I agree, but they do inject more capital into the US economy, which, in turn, gets spent and turned into wages & salaries, and hence Social Security and income tax payments.

Clive
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Re: What is the point of a dividend?

Post by Clive » Sun Mar 20, 2016 9:45 am

Valuethinker wrote:- there is a signalling content in dividends. It overcomes the asymmetric information problem between management and external shareholders. Because a dividend is in *cash* and cannot be manipulated (whereas profits can be) it is a signal of the quality of the underlying earnings for investors
Firms can pay dividends that amount to nothing other than a return of capital. Better to consider total return and depict the dividend amount taken/paid out of that total return oneself rather than a one size fits all. Return on assets (profitability) can be used instead of DCF.

lee71959
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Re: What is the point of a dividend?

Post by lee71959 » Sun Mar 20, 2016 10:42 am

I agree with those that say that dividends are tax-inefficient and the best return to shareholders long-term is with a non-dividend paying stock such as Berkshire, but only if the company is well run and won't squander the capital it has built - the basic question is if the company's management can make a greater return than what the market would otherwise offer (if shareholders received the dividend and then reinvested in a market portfolio) on the marginal capital not returned to shareholders . Of course, not every company can be Berkshire (with the confidence that people have in their management) because there's the fear that management will make suboptimal decisions when faced with lots of capital sitting around doing very little. In this case, it makes more sense to return the money to shareholders via dividend (or share buybacks), even with the tax drag, and let the shareholders invest those proceeds as they desire.

Dividends do impact investors in illogical psychology-based ways. Some investors will seek out high dividends even if it means a tax drag. Some investors want a constant dividend even when the business has trouble continuing to support it. Some of the dogmatic responses from experienced forum members illustrate the psychological hold that dividends have on many prudent investors. There is definitely a tax drag and investors do not get to determine their gains realizations (as they would if they simply sold shares when needed) when stuck on a quarterly dividend schedule.

The ultimate impact on returns between dividend-seeking and dividend-avoiding behavior is likely not nearly as material as savings rate, asset allocation, etc. but mathematically, there will be a lower return from the tax drag of high dividends versus the delaying of taxation through zero/low dividends within a portfolio.

Realistically, I don't believe you can fully avoid dividends if you have a taxable account (short of keeping your entire balance in Berkshire or equivalent companies which I wouldn't dare to do), but as has been noted already in thread, total market domestic/international index funds are fairly tax efficient and probably the best that most of us can do. However, that doesn't mean we should blindly extol the virtues of high dividend strategies when their impact to expected total after-tax returns is negative (versus zero/low dividend strategies).

dkturner
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Re: What is the point of a dividend?

Post by dkturner » Sun Mar 20, 2016 12:41 pm

lee71959 wrote:
The ultimate impact on returns between dividend-seeking and dividend-avoiding behavior is likely not nearly as material as savings rate, asset allocation, etc. but mathematically, there will be a lower return from the tax drag of high dividends versus the delaying of taxation through zero/low dividends within a portfolio.
You're assuming that your hypothetical investor I'm impacted by taxes on dividend income that could be avoided by purchasing non-dividend producing equities. That's true for individuals who hold equities in taxable accounts but endowments, foundations and retirement plans of every ilk are not impacted by taxes on the dividends their equity holdings produce. These types of investors represent a very significant segment of all equity holders - probably enough to insure that corporations make significant dividend payments regardless of whether it's in their best interests to do so.

Also with respect to dividends in taxable accounts you might take a look at Kenneth French's data on relative returns of dividend paying and non-dividend paying stocks. At dividend rates that have prevailed for the last 20 years, even after taxes, dividend paying stocks have returned more net cash to their owners than non-dividend payers have. Over that period dividend paying stocks have returned about 100 basis points more than non-dividend payers. That excess return leaves most income oriented investors ahead of their brethren who eschew dividends in their taxable accounts.

dbr
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Re: What is the point of a dividend?

Post by dbr » Sun Mar 20, 2016 12:48 pm

FWIW I recall reading a paper showing that the average market price decline on payment of dividends is close to the overall after tax value of the dividends, across all types of dividend receivers. In other words, the market as usual is very intelligent at valuing things. It would be true, therefore, that the tax disadvantages of dividends depend on the investors specific tax situation, an astonishing result.

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Re: What is the point of a dividend?

Post by garlandwhizzer » Sun Mar 20, 2016 12:51 pm

I haven't read the entire thread so please excuse me if someone has written this before. As to the question of taxes, dividends are taxable currently at the level of long term capital gains. So you pay taxes on your annual dividends but this also decreases the cost basis of your existing shares by an equivalent amount. When you do eventually sell your mutual fund shares, your share value has been lowered by dividend payments in an amount equal to the dividends, hence you pay less in long term capital gains taxes at that time. From a tax point of view, it is a wash amounting only to a zero percent interest loan to the IRS for the holding period of the shares. You pay the same rate either when you sell the shares or when the dividend is declared along the way. I don't find paying taxes on TSM in a personal account, about 2% annually at the reduced long term capital gains rate, a burden especially in view of the fact that my TSM cost basis is constantly being reduced which will decrease my future tax burden.

I am a total return not a dividend investor but I can see the other side of the coin. In general (with some exceptions) dividends are a screen for quality and value and tend to select for lower volatility, more established, higher financial strength stocks. Earnings per share can be manipulated by accounting gimmicks (EBIDA being an example, as well as outright fraud). Dividends are more difficult to manipulate--you have to come up with real money to pay them--although in that regard the recent trend for corporations to take on high levels of debt to finance dividends is worrisome. For conservative investors looking for and annual income stream, I think emphasizing dividend paying stocks can make sense.

Garland Whizzer

Valuethinker
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Re: What is the point of a dividend?

Post by Valuethinker » Sun Mar 20, 2016 1:34 pm

Clive wrote:
Valuethinker wrote:- there is a signalling content in dividends. It overcomes the asymmetric information problem between management and external shareholders. Because a dividend is in *cash* and cannot be manipulated (whereas profits can be) it is a signal of the quality of the underlying earnings for investors
Firms can pay dividends that amount to nothing other than a return of capital. Better to consider total return and depict the dividend amount taken/paid out of that total return oneself rather than a one size fits all. Return on assets (profitability) can be used instead of DCF.
ROA suffers from the credible signal problem. You can manipulate accounting numbers, but not dividends (or it's harder to use them as a manipulative signal in the long run).

Bfwolf
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Re: What is the point of a dividend?

Post by Bfwolf » Sun Mar 20, 2016 2:23 pm

HomerJ wrote:
Originally, the whole point of part-ownership in a company was to share in it's profits.

Your brother-in-law owns a dry cleaning store. You buy 10% of it. You get 10% of the profits each quarter. Why would you buy 10% of his store and let him keep all the profits?

I think it's crazy that he's convinced you to let him expand the store, telling you that re-investing the money instead of paying it out will make the company worth more. So you say "Awesome! So profits will go up, and then someday I'll get even bigger checks?"

"No, no... I'll NEVER pay you a cent. But you can sell parts of your shares to other people who also will never get a single dime of profit, but they will own a part of a company that is paying ME big profits each year."

Really, I don't understand the modern stock market at all. The original reason to own 0.0001% of a company was to get 0.0001% of the profits.

I really don't understand the whole idea of "We will NEVER pay our investors anything. They can just calculate how much the company is worth based on complicated accounting reports combined with vague predictions of future earnings, combined with emotional mood swings of millions of investors, meanwhile we'll just give ourselves large bonuses in actual cash from the profits that apparently they don't want".
You have created a straw man. All companies intend to return capital to their investors someday, either through dividends, stock buy-backs, or being bought out.

MrKnight
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Re: What is the point of a dividend?

Post by MrKnight » Sun Mar 20, 2016 2:34 pm

I think that this is an area where the Boglehead philosophy somewhat clashes with Corporate Finance Theory.

The 'strong' form of the Boglehead philosophy is that you should not bother analyzing any individual company, just invest in all of them for as cheaply as you can.

Corporate Finance Theory measures companies on an individual basis.

Of course, someone needs to measure companies on an individual basis. Otherwise, the entire Boglehead philosophy falls apart.

fortyofforty
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Re: What is the point of a dividend?

Post by fortyofforty » Sun Mar 20, 2016 8:08 pm

If the owners of a company don't want dividends paid out, they can vote for a new management team that doesn't pay dividends. A proxy vote might be one way to end dividends, but I'm not sure about the mechanics. Of course, it seems that a majority of shareholders of most dividend paying corporations either like them or don't care enough to want to change anything.

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