Dividends are beloved by investors and billions of dollars pour into dividend ETFs and stocks every year.
On Twitter, there are numerous accounts pushing the idea that dividends are your ticket to financial freedom.
They cite payouts from dividend stocks and ETFs: $800/month, $2,000/month, $35/month. They celebrate the “dividend day” for stocks like Pepsi and Apple, and laud the virtues of funds like SCHD - the Schwab US Dividend ETF.
But here’s the problem: dividends are only a PART of your total return.
They are not a bonus.
In other words, you could still have a negative return regardless of the dividend payout.
You are not getting “paid to wait.”
In fact, in a taxable account, you’re getting taxed to wait. Whether your total return is positive or negative, you pay taxes on those dividends.
All things being equal, if you were to get a 10% return on a stock, you’d be better off with as little of that return coming from the dividend as possible.
It’s a forced tax event.
Dividend Twitter would have you believe it’s almost free money. However, it’s really just a cashout on the value of your investment. The investment’s price goes down when it pays out the dividend, and then you get that amount in cash, which you can reinvest or do whatever you want with it.
This concept was explained well in an article by CFA Rubin J. Miller.
And this is a great breakdown of the various reasons not to be a dividend investor on the Optimized Portfolio website, which is a very good site.
Now this is not to say that dividend stocks can’t make good investments. Maybe it says something about the financial strength of the company, or maybe the company doesn’t know what to do with their money and they’re better off just paying it out to shareholders.
It makes people feel good to get a deposit from your investment every month or quarter.
Still, this payout in and of itself is not what makes you money.
It’s the total return (price appreciation plus dividend) that makes you money.
Take a stock like AT&T. Its dividend, on average, over the last five years has been 7%. It’s annualized total return during that period was -1%.
So you were “getting paid” to lose 1% every year for five years.
There is one way I could see dividends making sense.
I could see using dividends as some kind of drawdown strategy – you actively need the money and you’re only going to take out as much as your dividends are paying. However, if the total value of your portfolio goes down over time, you’ll just be facing decay of your assets.
But perhaps if you pick solid companies and only take out the dividends, there will be enough growth left over to sustain you. I’m just not sure that’s going to look much different than owning the total market and selling shares when you need cash.
You can use whatever strategy you feel comfortable with to achieve what you need, you just shouldn’t be fooled into thinking dividends are some sort of magic way to get there without risk.
A dividend is really no different than taking money out of an ATM - the only difference is with dividends you don’t have control over how often and how much money you’re taking out.