Why does dividend investing not work?

[Blendstar]

Hi Bogleheads!

I am new to this forum but I've been lurking for several months now so I know the general Boglehead philosophy and am very convinced that it is the way to go. I have been dollar cost averaging into a broad market worldwide ETF for a few months now and I really enjoy this passive investing strategy. I read a lot about investing as I'm trying to educate myself and also try to get to know other strategies that completely oppose the Bogleheads philosophy, in order broaden my knowledge and to make sure I am always able to come up with a reasoning that I can explain to myself why the Bogleheads Philosophy is the one for me. One topic I found on the internet is still something I am trying to get my head around and therefore I would like to ask what you fellow Boglehead's opinions are about the following.

I came across a Facebook page that promoted "dividend investing" and their members basically discuss building a dividend-paying stock portfolio. As a Boglehead I argue against actively "picking" individual stocks and instead opt for a total market passive index investing approach.
One individual that I've come across is the YouTube channel ppcian (https://www.youtube.com/user/ppcian). His strategy is dividend-growth investing and I see that this Facebook group, that I mentioned earlier, sometimes links his video's as a reference for their "strategy". I've been watching a few of his video's and he comes across as a knowledgeable guy that knows what he's doing and apparently it is working for him. However, I've read Burton Malkiel's book and therefore know that picking stocks (even dividend paying stocks) is extremely unlikely to outperform a broad market index in a multi decade time period.

What makes these 'dividend (growth) investors' so confident about their strategy? I really don't get it. It seems to me that they think receiving dividends is some sort of free-lunch, and they fail to see that a lot of higher yielding stocks are just getting their principle value hollowed out. Also these dividend stocks are presented as a class of "safer or better performing than non-dividend paying stocks", whereas I feel that dividend payment obligations for a company might actually be an extra risk, since now not only the stock can drop in value through bad results (etc. ), but can get another huge drop from a discontinuation or lowering of the dividend policy (if the company is in really bad weather).

What would be good arguments that one would need to convince someone who's new to investing that dividend investing is just the same as normal stock picking, except you get the "dividend" premium. Also, what do you think about PPCian and his strategy?

Would love to hear your idea's/opinions/arguments!

[Wakefield1]

I am not sure if "dividend investing" means the same thing to everyone who uses or hears the phrase
Am I a dividend investor for owning some Vanguard "Dividend Growth Fund"? For owning some broad market index (which pays dividends)(if just a little)
Diversification (not having too much in any one stock) or even owning some kind of index that emphasizes dividend income is supposed to be safer than owning one or a few stocks,whether those stocks pay high dividends or not (I believe that)
And there is taxation,but that differs between taxable and other types of accounts (like Roth)

[dbr]

Would love to hear your idea's/opinions/arguments!

Here are 26,700 ideas/opinions/arguments https://www.google.com/search?sitesearc ... +investing

[Jack FFR1846]

What’s the difference between a 10% total return of a stock and a 10% rise in a non-dividend paying stock in taxable?

You pay tax on dividends in the first case but not in the second.

So I guess if your goal is to pay more in taxes, go for those dividend payers

[willthrill81]

Here's the problem with how many investors look at dividends.

Let's say that I own a business outright. I transfer $1,000 from that business's checking account to my own personal checking account. Has my net worth increased by this move? No, because I owned the $1,000 the whole time; all I did was shuffle it around. The business is worth $1,000 less than it was before, and my checking account has $1,000 more in it.

Dividends are the same thing. I own shares in the company that holds the cash. Transferring my share of that cash to me does not improve my net worth. Dividends are not free money.

Whether our return comes from capital appreciation or dividends is irrelevant. Total return is what counts.

[permport]

In a nutshell, it doesn’t work because $1 is $1.

[animal_drawing]

Personally, I was very drawn to the idea of dividend growth investing, but I think it was for emotional reasons, not practical. As others have said, it's tax inefficient, and you want to focus on total return.

If stock A yields 5% but doesn't grow and stock B grows 5%/year, you can create the same cash flow that stock A gives by selling small portions of holdings of B over time. Of course, I want to passively manage my portfolio, I don't want to screw around setting up these cash flows, worrying about market timing, and sequences of return, etc, etc, so there's still something appealing about "free" dividend money.

The thing that got me to calm down and put my trust back in indexing was realizing that stock market indices already have a ~2% dividend yield built in. When you buy the whole market, you end up holding some dividend producing stocks, with very low risk that you're buying a value trap chasing 6+% yields. So, while many stocks yield more than 2%, do you want to take the risk that you can pick ones that won't crater in value? I don't think I can pick stocks, so no, I'd rather take my 2% and call it good.

[tibbitts]

Personally, I was very drawn to the idea of dividend growth investing, but I think it was for emotional reasons, not practical. As others have said, it's tax inefficient, and you want to focus on total return.

If stock A yields 5% but doesn't grow and stock B grows 5%/year, you can create the same cash flow that stock A gives by selling small portions of holdings of B over time. Of course, I want to passively manage my portfolio, I don't want to screw around setting up these cash flows, worrying about market timing, and sequences of return, etc, etc, so there's still something appealing about "free" dividend money.

The thing that got me to calm down and put my trust back in indexing was realizing that stock market indices already have a ~2% dividend yield built in. When you buy the whole market, you end up holding some dividend producing stocks, with very low risk that you're buying a value trap chasing 6+% yields. So, while many stocks yield more than 2%, do you want to take the risk that you can pick ones that won't crater in value? I don't think I can pick stocks, so no, I'd rather take my 2% and call it good.

Dividend growth investing has almost nothing to do with dividend investing. For example, a dividend growth fund might pay lower dividends than a total market fund.

[animal_drawing]

Dividend growth investing has almost nothing to do with dividend investing. For example, a dividend growth fund might pay lower dividends than a total market fund.

To expand on that, do you mean that dividend growth investing is the strategy of picking stocks that have been able to increase dividends over time, not stocks with high yields? And, the belief is that this strategy is good, because such companies historically performed well, by increasing dividends in the long run, and rising in value?

I still feel like many people are drawn to this strategy as an alternative to passive investing because the idea of owning a future income stream is emotionally appealing. Yields may start low, but from the DGI posts that I've read, posters talk a lot about how much they value the future cash flow, or how what they've acquired so far produces a good cash flow. Maybe their idea if DGI doesn't match yours, but that's what I'm picking up here.

I'm just saying the only way I was able to ignore all that hype was to remind myself that dividends are already a big part of the return of passive investing.

[patrick013]

Dividend indexes that are equal or yield weighted are very competitive with the market portfolio, even after taxes, and especially in a Roth.

[JustinR]

Because common people don't understand dividends and think it's magic free money being deposited into their bank accounts.

It's a psychological thing, similar to tax refunds.

[hirlaw]

Here's the problem with how many investors look at dividends.

Let's say that I own a business outright. I transfer $1,000 from that business's checking account to my own personal checking account. Has my net worth increased by this move? No, because I owned the $1,000 the whole time; all I did was shuffle it around. The business is worth $1,000 less than it was before, and my checking account has $1,000 more in it.

Dividends are the same thing. I own shares in the company that holds the cash. Transferring my share of that cash to me does not improve my net worth. Dividends are not free money.

Whether our return comes from capital appreciation or dividends is irrelevant. Total return is what counts.

I agree that the value is the same, but does the stock price go down the same amount to reflect that change in value? I am not sure that it does.

[cdu7]

The short answer is that it does work, just not as well as bogleheads investing would work. It’s a relic of a time before index funds really existed.

[JustinR]

Here's the problem with how many investors look at dividends.

Let's say that I own a business outright. I transfer $1,000 from that business's checking account to my own personal checking account. Has my net worth increased by this move? No, because I owned the $1,000 the whole time; all I did was shuffle it around. The business is worth $1,000 less than it was before, and my checking account has $1,000 more in it.

Dividends are the same thing. I own shares in the company that holds the cash. Transferring my share of that cash to me does not improve my net worth. Dividends are not free money.

Whether our return comes from capital appreciation or dividends is irrelevant. Total return is what counts.

I agree that the value is the same, but does the stock price go down the same amount to reflect that change in value? I am not sure that it does.

Yes it does. That's the whole point.

Dividends do not increase your wealth at all, but are actually a net loss due to taxes.

Dividends are similar to a company forcing you to sell your stocks, but worse (in several ways).

That's why many people here don't like or actively avoid dividends. Read any Bogleheads guidance on avoiding "buying the dividend."

[willthrill81]

It's a psychological thing, similar to tax refunds.

"I didn't pay anything in income taxes last year. I got a refund."

[Riprap]

What’s the difference between a 10% total return of a stock and a 10% rise in a non-dividend paying stock in taxable?

You pay tax on dividends in the first case but not in the second.

So I guess if your goal is to pay more in taxes, go for those dividend payers

This is simply not true in many cases, especially for retirees. Dividend paying stocks can actually be more tax efficient than generating income from sales of appreciated shares in some cases. It's best to ignore blanket statements like Jack makes.

See for yourself using TaxAct Estimator linked below.

https://www.taxact.com/tools/tax-calcul ... lsrc=aw.ds

[JustinR]

What’s the difference between a 10% total return of a stock and a 10% rise in a non-dividend paying stock in taxable?

You pay tax on dividends in the first case but not in the second.

So I guess if your goal is to pay more in taxes, go for those dividend payers

This is simply not true in many cases, especially for retirees. Dividend paying stocks can actually be more tax efficient than generating income from sales of appreciated shares in some cases. It's best to ignore blanket statements like Jack makes.

That's literally impossible. Please show us the math on how dividends can be more tax efficient than sold shares.

[Riprap]

What’s the difference between a 10% total return of a stock and a 10% rise in a non-dividend paying stock in taxable?

You pay tax on dividends in the first case but not in the second.

So I guess if your goal is to pay more in taxes, go for those dividend payers

This is simply not true in many cases, especially for retirees. Dividend paying stocks can actually be more tax efficient than generating income from sales of appreciated shares in some cases. It's best to ignore blanket statements like Jack makes.

That's literally impossible. Please show us the math on how dividends can be more tax efficient than sold shares.

I just plugged in $85,000 in qualified dividend income for a married couple. No other income. Tax liability = $0

$85000 in short term capital gains for same couple Tax liability = $6,942

$40K in short term/$45k long term Tax liability = $1,603

There...I showed you. Point is...you can have substantial qualified dividends without generating income taxes.

[andrew99999]

What makes these 'dividend (growth) investors' so confident about their strategy? I really don't get it. It seems to me that they think receiving dividends is some sort of free-lunch, and they fail to see that a lot of higher yielding stocks are just getting their principle value hollowed out. Also these dividend stocks are presented as a class of "safer or better performing than non-dividend paying stocks", whereas I feel that dividend payment obligations for a company might actually be an extra risk, since now not only the stock can drop in value through bad results (etc. ), but can get another huge drop from a discontinuation or lowering of the dividend policy (if the company is in really bad weather).

What would be good arguments that one would need to convince someone who's new to investing that dividend investing is just the same as normal stock picking, except you get the "dividend" premium. Also, what do you think about PPCian and his strategy?

Here is how I explain the fallacy of dividend investing.

-------------------------

Dividends are arbitrary.

A company has earnings.

It then pays out some of those earnings as dividends and retains the rest to grow the business. The same company with the same earnings can pay out 80% or 20% or any other amount of earnings and it will make no difference to your total return.

The more they pay out in dividends, the less that is retained to grow the business, and therefore growth is reduced by the amount that was paid out in dividends.

Dividends are not free money. They come out of the total return.
You can even see it happen in real time when companies/funds goes ex-dividend and the share price drops the amount of the dividend being paid out.

As a result, you get less compounding – unless you re-invest the excess, in which case what was the point of higher dividends in the first place.

On top of this, by going with only the high yielding companies, you face concentration risk through lack of diversification.

Some further reading/watching -

https://www.cnbc.com/2016/12/08/dont-bu ... warns.html
https://www.youtube.com/watch?v=UpXI_Vd51dA&t=9s
https://www.bogleheads.org/wiki/Why_did ... p_in_value
viewtopic.php?f=1&t=258311
https://www.forbes.com/sites/jimdahle/2 ... 394c797479
https://earlyretirementnow.com/2019/02/ ... s-part-29/

[OT comments removed by admin LadyGeek]

[tibbitts]

Dividend growth investing has almost nothing to do with dividend investing. For example, a dividend growth fund might pay lower dividends than a total market fund.

To expand on that, do you mean that dividend growth investing is the strategy of picking stocks that have been able to increase dividends over time, not stocks with high yields? And, the belief is that this strategy is good, because such companies historically performed well, by increasing dividends in the long run, and rising in value?

I still feel like many people are drawn to this strategy as an alternative to passive investing because the idea of owning a future income stream is emotionally appealing. Yields may start low, but from the DGI posts that I've read, posters talk a lot about how much they value the future cash flow, or how what they've acquired so far produces a good cash flow. Maybe their idea if DGI doesn't match yours, but that's what I'm picking up here.

I'm just saying the only way I was able to ignore all that hype was to remind myself that dividends are already a big part of the return of passive investing.

I believe that many active dividend growth fund managers choose stocks that either have a history of increasing payouts (maybe increasing from ultra-tiny to merely super-tiny - an increase from .01% to .02% is a huge percentage increase, after all), or even stocks that have never paid a dividend, but that fund managers believe will pay a dividend in the near future.

[mhadden1]

What’s the difference between a 10% total return of a stock and a 10% rise in a non-dividend paying stock in taxable?

You pay tax on dividends in the first case but not in the second.

So I guess if your goal is to pay more in taxes, go for those dividend payers

This is simply not true in many cases, especially for retirees. Dividend paying stocks can actually be more tax efficient than generating income from sales of appreciated shares in some cases. It's best to ignore blanket statements like Jack makes.

That's literally impossible. Please show us the math on how dividends can be more tax efficient than sold shares.

I just plugged in $85,000 in qualified dividend income for a married couple. No other income. Tax liability = $0

$85000 in short term capital gains for same couple Tax liability = $6,942

$40K in short term/$45k long term Tax liability = $1,603

There...I showed you. Point is...you can have substantial qualified dividends without generating income taxes.

Pretty sure that the original idea was that an unrealized 10% capital gain is not even a taxable event while a 10% dividend is, although perhaps paid at a 0% rate. I don't find this response that much of a touche'.

[nedsaid]

Dividend investing is much trashed here but I don't subscribe to the conventional wisdom on this forum. First, let me say that dividends are not magic. They aren't free money. All other things being equal, the price of a stock will drop by the amount of the dividend on ex-dividend date. We know that markets account for cash on the balance sheet, cash rich companies tend to trade at higher P/E ratios than companies with less cash on the balance sheet.

If dividend investing works, it is because of the underlying factors. High Dividend tends to outperform the market because these stocks tend to have Value characteristics and tend to be lower volatility stocks. Dividend Growth tends to outperform because of the Quality/Profitability factor. If you take into account factors, dividends are neutral to stock performance.

I like dividends because they are an indication of cash flow and earnings. They have to be paid with real cash. Dividends are much harder to manipulate than earnings. I do remember the days of when I owned shares of Occidental Petroleum, I sold when I realized that the company was raising cash with new issues of stock to pay the dividend. The dividend was otherwise unsustainable because the payout was higher than earnings. But this is a pretty rare case. It was paying .3125 cents a share until 3/6/1991 when it was cut to .125 cents a share, a 60% cut. Think I sold before the dividend cut. Having to reach way back in those foggy memory banks, but that is what I recall.

Dividend growth most often means that underlying earnings are growing too. Hence the association with Profitability/Quality.

High dividend often means the company is mature and in a slow growth phase, the company chooses to pay out excess case rather than make questionable mergers with other companies. The slow growth High Dividend stocks also tend to be associated with Low Volatility which also tends to beat the market over time. So you have overlap between Low Vol and Value. Many of these are also regarding as the defensive stocks, the theory being that higher dividend yields cushion the losses from a bear market.

Jeremy Seigel is a believer in dividend investing, though that is a minority view in the Academic community.

[Time2Quit]

What makes these 'dividend (growth) investors' so confident about their strategy? I really don't get it. It seems to me that they think receiving dividends is some sort of free-lunch, and they fail to see that a lot of higher yielding stocks are just getting their principle value hollowed out. Also these dividend stocks are presented as a class of "safer or better performing than non-dividend paying stocks", whereas I feel that dividend payment obligations for a company might actually be an extra risk, since now not only the stock can drop in value through bad results (etc. ), but can get another huge drop from a discontinuation or lowering of the dividend policy (if the company is in really bad weather).

What would be good arguments that one would need to convince someone who's new to investing that dividend investing is just the same as normal stock picking, except you get the "dividend" premium. Also, what do you think about PPCian and his strategy?

Here is how I explain the fallacy of dividend investing.

-------------------------

Dividends are arbitrary.

A company has earnings.

It then pays out some of those earnings as dividends and retains the rest to grow the business. The same company with the same earnings can pay out 80% or 20% or any other amount of earnings and it will make no difference to your total return.

The more they pay out in dividends, the less that is retained to grow the business, and therefore growth is reduced by the amount that was paid out in dividends.

Dividends are not free money. They come out of the total return.
You can even see it happen in real time when companies/funds goes ex-dividend and the share price drops the amount of the dividend being paid out.

As a result, you get less compounding – unless you re-invest the excess, in which case what was the point of higher dividends in the first place.

On top of this, by going with only the high yielding companies, you face concentration risk through lack of diversification.

Some further reading/watching -

https://www.cnbc.com/2016/12/08/dont-bu ... warns.html
https://www.youtube.com/watch?v=UpXI_Vd51dA&t=9s
https://www.bogleheads.org/wiki/Why_did ... p_in_value
viewtopic.php?f=1&t=258311
https://www.forbes.com/sites/jimdahle/2 ... 394c797479
https://earlyretirementnow.com/2019/02/ ... s-part-29/

[OT comments removed by admin LadyGeek]

From my own unscientific observation: In general young companies rarely pay dividends, as they mature and their growth prospects slow they pay dividends. AAPL is a perfect example, INTC and MSFT are examples as well. Although dividends are not free money, when a company pays dividends it shows they have a strong balance sheet. A company that “retains” earning could be hiding something that is structurally wrong with a company and will take sometime to discover (Enron and Washington Mutual comes to mind which were the darling growth stocks.)

VTSAX/VTI pays close to a 2 percent dividend and people love it. (a little hippocracy here). Why not make an index of non-dividend paying stocks? With 3000k+ companies that
at make up the index, they still average close to a 2% dividend. Why don’t all these companies just cut their dividends to zero and re-invest and grow, since not paying dividends is so great?

If I told employees I will give them the option:
Pay them a bonus now or withhold their bonus this year so the company can retain the earnings and grow the company. With the promise of a higher payout in the future. Which option do you think most will take?

I view a dividend as a good faith payment by the company to keep them honest.

[JustinR]

What’s the difference between a 10% total return of a stock and a 10% rise in a non-dividend paying stock in taxable?

You pay tax on dividends in the first case but not in the second.

So I guess if your goal is to pay more in taxes, go for those dividend payers

This is simply not true in many cases, especially for retirees. Dividend paying stocks can actually be more tax efficient than generating income from sales of appreciated shares in some cases. It's best to ignore blanket statements like Jack makes.

That's literally impossible. Please show us the math on how dividends can be more tax efficient than sold shares.

I just plugged in $85,000 in qualified dividend income for a married couple. No other income. Tax liability = $0

$85000 in short term capital gains for same couple Tax liability = $6,942

$40K in short term/$45k long term Tax liability = $1,603

There...I showed you. Point is...you can have substantial qualified dividends without generating income taxes.

I mean, you're comparing dividends to short term capital gains. No retiree (or any investor) is selling short term stocks for income.

Also, the entire dividend is taxed, whereas only the gain is taxed on a sold stock.

[DonIce]

Companies have the option of paying out money as dividends or reinvesting it in their own growth. If they can't re-invest in a way that generates worthwhile growth, then paying dividends is the better option. This is often true in the case of companies that are relatively "fixed" and don't have limitless growth opportunities, like utilities for example. Avoiding dividend paying companies in your asset allocation means avoiding this sector (and other sectors) of the economy, which reduces diversification. Similarly, focusing solely on dividend paying companies means avoiding companies that are in the rapid growth and re-investment phase, which also reduces diversification. Better to own a diversified fund/etf that invests in the whole market and get both.

Regarding the tax issues, it all depends. The majority of investors don't contribute more per year to investment accounts than what they can fit into tax-advantaged accounts, so for them the tax differences don't matter. For those that do hold equities in taxable accounts, if they are in the distribution phase and have to sell off shares to generate cashflow, the tax rate on long term capital gains is the same as on qualified dividends (and most dividends should be qualified). For those that are in the accumulation phase in taxable accounts, dividends do generate taxable events whereas share price appreciation does not so in that case they are a disadvantage.

As for what to do with dividends you do get, it is better for them to be automatically re-invested. If they aren't automatically re-invested, then the cash will sit around in your account doing nothing until the next time you log on and execute some trades, which will reduce your long term returns.

[bhsince87]

What do you mean by "not work"?

It CAN work perfectly well.

But it has shown no benefit over total return investing, and in some situations can be worse.

If such an approach motivates people to save and invest, more power to them. But it's no magic bullet for guaranteed returns or beating "the market".

[andrew99999]

From my own unscientific observation: In general young companies rarely pay dividends, as they mature and their growth prospects slow they pay dividends. AAPL is a perfect example, INTC and MSFT are examples as well. Although dividends are not free money, when a company pays dividends it shows they have a strong balance sheet. A company that “retains” earning could be hiding something that is structurally wrong with a company and will take sometime to discover (Enron and Washington Mutual comes to mind which were the darling growth stocks.)

A company can also hide something by paying dividends when earnings are not strong by selling down assets or using retained cash for dividends.

VTSAX/VTI pays close to a 2 percent dividend and people love it. (a little hippocracy here). Why not make an index of non-dividend paying stocks? With 3000k+ companies that make up the index, they still average close to a 2% dividend. Why don’t all these companies just cut their dividends to zero and re-invest and grow, since not paying dividends is so great?

Just because they payout 2% doesn't mean that 2% gives any better "return" than no dividends just as it doesn't mean it gives a worse "return" than 4% dividends.

Also, I read there is a penalty for not paying out any dividends which is why it is paid out. I did not keep a reference to it though.

If I told employees I will give them the option:
Pay them a bonus now or withhold their bonus this year so the company can retain the earnings and grow the company. With the promise of a higher payout in the future. Which option do you think most will take?

If it was a company I actually believed in, or a broad index, the dividend has literally no meaning to me whatsoever. Just because people "feel good" with a dividend does not make it any different.


Sorry but these reasons don't appear at all based on logic or reasoning and appear to be just arguments one would use as a way to try and confirm their bias rather than looking at any facts.

[-ryan-]

There's some historical significance that favored dividends:

Before mutual funds and index funds were commonplace, small investors used to buy individual stocks (no surprise there), and often starting with just a few shares in one or two companies. If you were a smart investor, you sought high dividend payouts in those initial holdings. That's because you wanted to invest those dividends in shares of other companies to diversify into 10-30 companies in a variety of sectors. Often we think of dividend reinvestment as buying more of the same company or fund, but in the past that was generally not the case. You reinvested the dividends, but often into different companies.

There's also the fact that by receiving dividends as income rather than selling shares you retain your proportional ownership of stock (though secondary offerings can create a risk of share dilution for owners), but with mutual funds that's a non issue as you don't have the same shareholder responsibilities as you would directly owning stock.

I suppose if your aim is to build a diversified portfolio of individual stocks as quickly as possible, going for the high dividend payers first is generally a good strategy, but having done both (including professionally) I don't see a reason to hold individual stocks over index funds other than as a fun diversion.

[22twain]

I read there is a penalty for not paying out any dividends which is why it is paid out.

If this is true, then Berkshire Hathaway must be paying huge penalties.

[andrew99999]

I read there is a penalty for not paying out any dividends which is why it is paid out.

If this is true, then Berkshire Hathaway must be paying huge penalties.

Yes I wondered about that too, but since it has no effect on me I didn't bother checking further into it.

[deltaneutral83]

People that place significant value in dividend paying stocks probably also think getting a tax refund is of more significant value.

[JoMoney]

Dividend investing does work, so do lots of other strategies.
Is someone claiming that it's "better" at something specific?
I would say it's worse for taxes, and potentially transaction costs if you're not in a withdrawal stage where you need the income. It also can potentially leave you less "diversified" or more concentrated in certain sectors and styles of stocks that tend to have higher yields. If you use DRIPs and individual stocks you can also end up with a lopsided portfolio where a few of your stocks make up a very large proportion of your portfolio. A portfolio of individual stocks can be unwieldy to manage and "rebalance" or even to figure out how to withdraw from. There's a bunch of behavioral traps that it's easy to fall into when playing with individual stocks, like "falling in love with a stock".
I believe a "dividend growth" strategy may be a way to select stocks that are slightly more likely to be "quality" stocks, and a "high dividend" strategy may be slightly more likely to tilt towards "value" stocks. There are characteristics associated with those styles that some people may consider better than others, but there are other ways to go about the same strategy, and it's not necessarily the case that those strategies offer any free-lunch on a basis of risk and return, just slightly different risk profiles with different characteristics.
Dividends are the most obvious, reported on, and over-sold metric/valuation strategy out there. There's nothing secret or magic going on there... but that doesn't mean it's any better or worse than other strategies, which would make it difficult to convince someone that's sold on it that there's nothing there.

[hornet96]

I read there is a penalty for not paying out any dividends which is why it is paid out.

If this is true, then Berkshire Hathaway must be paying huge penalties.

Yes I wondered about that too, but since it has no effect on me I didn't bother checking further into it.

I don’t have the reference handy, but the requirement is that mutual funds under the investment company act of 1940 are required to pay out accumulated dividends to its shareholders. There is no requirement for individual companies to pay out dividends (which is what Berkshire Hathaway is).

[snailderby]

Welcome to the forum, Blendstar!

There are several types of "dividend investors":

1. Some dividend investors believe that dividends are free money. This is not true, as willthrill81 (and others) pointed out.

2. Some dividend investors are stock pickers. They buy and hold individual dividend stocks. (I believe ppcian falls into this category.) Some people who do this have outperformed the S&P 500. Others haven't.

3. Other dividend investors like to buy and hold index funds that focus on (a) high-dividend-yield stocks or (b) stocks that have grown their dividends every year for a long period of time. VYM is an example of the first approach, and VIG is an example of the second approach. This is arguably the most innocuous form of dividend investing, as most of these funds still (i) track an index, (ii) hold dozens or even hundreds of stocks, and (iii) charge a low fee. In addition, to back up JoMoney's statement earlier, VYM has historically had a value tilt, while VIG has historically had a quality tilt. See https://www.portfoliovisualizer.com/fac ... sion=false.

[lostdog]

I'll take tax efficiency and some qualified dividends over dividend investing any day.

Total return and tax-efficiency for the win.

[alpine_boglehead]

It does work. If you hold a well-diversified basket (across sectors, maybe even countries) of dividend paying stocks, you won't be off too badly, and will probably earn something not too far from the market return.

However, holding the total market is more diversified and more tax-efficient.

As other have said, it's a psychological thing. "Seeing" your investments produce a regular income stream is nice, after all. It's easier to believe that you've gained something when you get money wired into your account, as opposed to "just" seeing the value of your investments increase over time (with lots of short-term fluctuations and noise on the way). With 20% market swings, you don't get to see the 5% your holdings increased in value. But you can see the additional $5000 on your account balance.

[linenfort]

I still feel like many people are drawn to this strategy {dividend growth investing} as an alternative to passive investing because the idea of owning a future income stream is emotionally appealing. Yields may start low, but from the DGI posts that I've read, posters talk a lot about how much they value the future cash flow, or how what they've acquired so far produces a good cash flow. Maybe their idea if DGI doesn't match yours, but that's what I'm picking up here.

That was certainly the case for me before I discovered bogleheads. Exactly as you said.
Also, I haven't reached the level where taxes are an issue. Essentially zero taxes on dividends.

[KyleAAA]

It does work, just no better than total return investing in tax deferred and much worse in taxable.

[Caduceus]

The best way to understand this is to study the financial statements of companies that pursue different capital allocation policies through time. You will get a clear picture of how dividends affect the financial position of a company.

Broadly speaking, firms have three ways to utilize the cash earnings that they generate. They can (1) retain the earnings, using these earnings for acquisitions or for internal projects that grow future profitability, (2) use the cash earnings to repurchase shares, thereby increasing the stake that each existing shareholder has on the future cash flow of the company, or (3) issue dividends.

There is no one correct capital allocation policy for all firms, which is why "dividend-investing" is a fundamentally stupid idea. You can study the examples of many, many companies. Look at Option 1- retention of earnings. Some companies have retained the earnings and completely wasted it - this is especially true in the modern era of capital allocation, when you have an army of investment bankers and management consultants convincing cowboy CEOs that this or that acquisition is a great idea. Examples: Microsoft's acquisition of Nokia, or Yahoo's acquisition of Tumblr. Examples are plentiful. The writedowns were real - the shareholder losses equally real and painful.

Now look at Option 2: share repurchases. This used to be a great idea. The increase in shareholder value of the Washington Post was driven in great part by smart share repurchases that took place at prices well under the intrinsic share prices of the firms. The problem in the modern era are corporate incentives - because senior management these days are often paid in option grants, they have an incentive to repurchase company shares at any prices - even at nosebleed valuations - because this will cause a larger increase in share prices compared to dividend issuance. Warren Buffett has mentioned that he believes the vast majority of share repurchases take place at silly prices and should not have been done.

Option 3: Dividends - you would think was a safe policy - but examples abound of silliness too. ArcelorMittal at one point was borrowing at a marginal rate higher than its dividend rate in order to maintain its dividend. Companies that issue dividends are loath to cut dividends even when it might be a good idea because of the "signal" it sends to Wall Street analysts. So they take on debt, or cut back on important projects for the future, all to satisfy a shareholder base addicted to constant payouts. Do you really want to invest in a company with a high dividend policy that they are maintaing only by borrowing at ridiculous rates because of their credit rating?

The bottom line is this. Anyone who says that "dividend investing" is great or not great has zero understanding of how finance works, and has never, ever read an annual report. No need to waste time engaging with them. Dividends are a great idea for some companies and not others; same with earnings retention, and again with share repurchases. For most companies, what is a good capital allocation policy at one time is not a good idea at another time.

[patrick013]

https://us.spindices.com/documents/rese ... nload=true

See exhibit 10 and 14 above. Dividend indexes that beat the 500 generally have 50-100 stocks and are yield or equal weighted. Read something by O'Shaughnessy about dividends. He'd probably approve of the above indexes and funds. The samples in his study's are similar. S&P Dow Jones indexes are a pretty good market sample.

Dividends are a good thing. You will see dividends increase in large cap indexes as the index price increases. Profitable companies in the upper tier of returns exhibit even higher returns above lower tiers when dividends are increased and as a resulting multiple of that increase. The facts and prices and after tax total returns are in various studies. Show me the studies.

[SGM]

Dividends are almost unavoidable. Taxes on dividends in a taxable account can be a drag on returns. I wouldn't say dividend investing doesn't work, but I prefer a total return approach. I was once more enamored of dividends when I used drips back when stock purchases were more expensive.

In later days when I sold long held Berkshire Hathaway stock to diversify I was surprised by how much additional taxes I had to pay when I started receiving a lot more dividends even if it was in the total stock market fund.

Reaching for higher dividends can also increase risk and make your portfolio less diverse.

As a retiree I spend my dividends or reallocate them. I am less likely to sell stock or stock funds with large capital gains as I already have the tax drag of a large amount of dividends.

[mptfan]

The headline of your thread asks "Why does dividend investing not work?" as if most Bogleheads believe that dividend investing "does not work," but I don't think Boglehead principles teach that dividend investing does not work. I think most Bogleheads would agree that dividend investing does work.

[RAchip]

“In a nutshell, it doesn’t work because $1 is $1.“

This is the flaw in the dividend bashers argument. It is wrong. $1 in your pocket is worth far more than $1 held by a company that you own a tiny fraction of. Cash in a company has no incremental value unless it is a non-operating asset. A company that holds on to non-operating assets is, by definition, mismanaging its assets.

[dbr]

The headline of your thread asks "Why does dividend investing not work?" as if most Bogleheads believe that dividend investing "does not work," but I don't think Boglehead principles teach that dividend investing does not work. I think most Bogleheads would agree that dividend investing does work.

Yes, most people here would say dividend investing does work in that one can get returns similar to market returns at risk similar to market risk. For example a comparison of the total return over time of a Vanguard dividend fund is actually very close to the return over time of a low cost total market fund. That works for me as long as tax costs aren't an issue and maybe even if taxes are a small issue.

I think the idea is that the "dividend investor" is imagined able to get much better returns for the same risk as, for example, an investor who just holds the total market. When one says dividend investing "doesn't work" that would mean that dividend investing does not get much better returns at all.

The extreme of this would be someone under the illusion that dividends are free money. Such an investor would imagine that he can earn a return 4% better than the return of the total market if he is getting a dividend of 6% when the market is paying 2%.

Whatever variation on this theme of a better way to invest one might find would be the contentions that most people here say "does not work."

[jsprag]

Dividends have their place. Some companies, for example, may have earnings that cannot be effectively or efficiently translated to growth due to market conditions, industry factors, or management limitations.

Any claim that retained earnings are ALWAYS better than dividends for every business (and every investor in that business) during every cycle is a gross oversimplification.

[dbr]

Dividends have their place. Some companies, for example, may have earnings that cannot be effectively or efficiently translated to growth due to market conditions, industry factors, or management limitations.

Any claim that retained earnings are ALWAYS better than dividends for every business (and every investor in that business) during every cycle is a gross oversimplification.

And nobody claims that. The issue under discussion is whether or not screening for dividends is a reliable way to produce better results on the contention that paying dividends would always be superior to retaining a large fraction or all of the earnings for every business during every cycle. What is being rejected is the opposite oversimplification of the gross oversimplification you suggest (which I agree is a gross oversimplification).

That is aside from contentions that are nothing more than mathematical illiteracy.

[jeffreyalan]

I am a dividend growth investor myself. I will say that I do not in any way believe that dividends are "free money." I am well aware of the fact that I could buy an index fund, sell off shares as I need them and possibly achieve the same goals (tax issues notwithstanding).

However, the reason I choose to follow this strategy is because it is fairly low maintenance for me. Over time I find a group of stocks that have raised their dividend consistently over many years and I purchase them at a fair price. Think stocks like MMM or JNJ for example. Then once I buy them I forget about them (unless the unlikely event of a dividend cut occurs) and just collect my quarterly deposits which I spend or invest again. I never have to worry about selling x number of shares, possibly after a market drop and then worrying about whether or not I will outlive my funds or not since this way I am forced to live on the dividends and never touch the "principal" of my stocks. Also, if I concentrate on the consistently rising dividends I receive and do not pay attention to the fluctuations in price, it keeps me from making kneejerk decisions on selling when the market gets rough. And I am leaving a (hopefully) rising stream of income for my heirs. It is not magical. It is just the way I choose to invest for myself.

[jsprag]

Dividends have their place. Some companies, for example, may have earnings that cannot be effectively or efficiently translated to growth due to market conditions, industry factors, or management limitations.

Any claim that retained earnings are ALWAYS better than dividends for every business (and every investor in that business) during every cycle is a gross oversimplification.

And nobody claims that. The issue under discussion is whether or not screening for dividends is a reliable way to produce better results on the contention that paying dividends would always be superior to retaining a large fraction or all of the earnings for every business during every cycle. What is being rejected is the opposite oversimplification of the gross oversimplification you suggest (which I agree is a gross oversimplification).

That is aside from contentions that are nothing more than mathematical illiteracy.

Disagree on your first point. There are several claims (or, at least, the same claim repeated several times) that $1 in dividends always leaves the investor worse off, due to taxes, than $1 in retained earnings. That depends heavily on what the business does with the $1 of retained earnings...

We're in agreement on the larger point - that dividends (or lack thereof) is not a universally reliable predictor of improved outcomes.

[dbr]

I am a dividend growth investor myself. I will say that I do not in any way believe that dividends are "free money." I am well aware of the fact that I could buy an index fund, sell off shares as I need them and possibly achieve the same goals (tax issues notwithstanding).

However, the reason I choose to follow this strategy is because it is fairly low maintenance for me. Over time I find a group of stocks that have raised their dividend consistently over many years and I purchase them at a fair price. Think stocks like MMM or JNJ for example. Then once I buy them I forget about them (unless the unlikely event of a dividend cut occurs) and just collect my quarterly deposits which I spend or invest again. I never have to worry about selling x number of shares, possibly after a market drop and then worrying about whether or not I will outlive my funds or not since this way I am forced to live on the dividends and never touch the "principal" of my stocks. Plus I am leaving a (hopefully) rising stream of income for my heirs. It is not magical. It is just the way I choose to invest for myself.

There is no such thing as "not touching the principal." Spending the dividends is a withdrawal and a withdrawal is a withdrawal is a withdrawal. In fact, the more of the return is accounted for by dividends the greater is the risk of withdrawing so much money. Fortunately stocks such as those you mention pay modest dividends such that the portfolio is sustainable under that rate of withdrawal. So far you are the beneficiary of good luck holding stocks such as you mention, but the risk is humongous compared to holding a diversified fund of stocks whatever the dividends, unless you are already talking about dozens of stocks. So long as your luck holds out you will leave a good amount of wealth to your heirs while actually having spent much less than you might have.

[ChinchillaWhiplash]

If all your holdings are in a tax deferred account, I don't think there is a difference as long as they both return the same amount. You can also hold things like a high yield municple bond fund in a taxable and pay no taxes on dividend payments. How about the unusual structure of REITs, BDCs, etc that have to pay back 90% of profit to shareholders if held in a tax deferred account? Seems like some of those can have pretty nice returns over a long period, especially if the dividends are reinvested. So, I think one COULD be successful at dividend investing, but it might not have the best performance or be very easy to pick the right stocks to make it work over a simple, tax efficient, indexed fund portfolio.