Investing

Why Dividend Investing is not a great idea

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  • Sep 24th, 2020 5:53 pm
[OP]
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Nov 9, 2013
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Edmonton, AB

Why Dividend Investing is not a great idea

Why, as an investor, do you desire a dividend then if you're reinvesting it? The company's financials would be better off and you as the investor would be better off after tax if the company held on to that cash instead of dividending it out. If you're retired or retiring soon, you can decide when to take cash flows and sell portions of the investment as needed.

Dividend-focused investing is sheer lunacy!
*

mod edit: let's please not start this thread by being confrontational. Feel free to have a civil discussion about why dividend investing may not be a great idea.
Keep calm and go long
160 replies
Deal Addict
Sep 20, 2014
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Toronto, ON, CA
Not every company would benefit from re-investing their dividends.
Usually the industries that pay dividends are at their peak, they're not growth stocks, so investing in R&D/product development for the sake of it seems dumb.
If a project was on the table that was profitable, there is no questions they'd fund it, if it wasn't profitable - why fund it? Might as well pay a dividend.
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Dec 14, 2010
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Dividends are in control of the business. Price is not. Dividends from quality companies are fairly reliable. But you don’t know when capital gains will show up. And when price drops (many times unrelated to business performance), one needs to sell more shares to produce the same income. The more they sell, to meet that income, the more the engine that produces such cash flow gets depleted.

Dividends is what allows one to build a perpetual income machine (if that’s your goal).

If my goal is income, I rather take the dividend, which gives me the option to reinvest or spend. If the goal is capital appreciation, I rather invest in growth stocks, that might or might not pay dividends. Different strategies, for different goals.


Rod
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As per my edited post at the top - i've changed the title and removed some posts. All I'm asking from everyone is to have a civil discussion. That means no name calling, calling people out, or other such shenanigans. What you may consider to be the perfect strategy may not hold true for someone else. Just accept that and move on if things get too heated.
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Regarding the modified question “Why, as an investor, do you desire a dividend then if you're reinvesting it?”

Because one can choose to invest the dividends on the same company (if fairly valued) or other companies (case this one is overvalued). When a business is overvalued, I rather take the cash and deploy somewhere else. With the added benefit that I can spend if I want, without harvesting the engine that generate that income. And when the shares are undervalued or we are in a market downturn period, dividends are capital that can be reinvested, purchasing more shares, at a higher yield, which in turn will pay more dividends, compounding that investment further.


Rod
Build a comprehensive portfolio based on Investing and Trading strategies. Check out these threads and join the discussion:

Investing strategy based on dividend growth

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Deal Fanatic
Jul 1, 2007
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We should discuss how dividend-focused investing is a behavioural investing flaw. It is causing Canadian investors to expose themselves to additional risks, eschewing diversification in an irrational quest for dividends.

All the amateur investors with blogs and YouTube channels preaching this flawed strategy aren't helping.
Money Smarts Blog wrote: I agree with the previous posters, especially Thalo. {And} Thalo's advice is spot on.
Jr. Member
Mar 1, 2016
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Thalo wrote: We should discuss how dividend-focused investing is a behavioural investing flaw. It is causing Canadian investors to expose themselves to additional risks, eschewing diversification in an irrational quest for dividends.

All the amateur investors with blogs and YouTube channels preaching this flawed strategy aren't helping.
I thought that was the idea of this thread instead of it constantly seeping into and derailing the other dividend-related threads.
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Thalo wrote: We should discuss how dividend-focused investing is a behavioural investing flaw. It is causing Canadian investors to expose themselves to additional risks, eschewing diversification in an irrational quest for dividends.

All the amateur investors with blogs and YouTube channels preaching this flawed strategy aren't helping.
How is a dividend an additional risk? It’s cash, capital that can be reinvested on the same company, or another company, or spent, while keeping the same engine that produces such cash flow.

Lots of companies in March that reinvested their cash back, but did that help investors if they need income? How does that help the investor to average down with such opportunities? Or in 2016, 2011 or 2008? Dividends can be reinvested back, for a higher yield, which in turn produces further cash, which can be compounded further or spent. How is that extra risk?

Specially for new investors, it’s a lot easier to endure market gyrations because dividends continue to come despite price volatility. Dividends are paid on the number of shares you own and not affected by the price volatility of those shares. Therefore, even in a bear market when prices are dropping, your dividend income can still be rising. Which becomes an edge, since this is capital that can be reinvested on companies that got cheaper for reasons unrelated to the business itself. Unlike a company that doesn’t pay dividend, where you can’t add to those opportunities, unless you provide additional funding. How are dividends a flawed strategy in this setup?



Rod
Build a comprehensive portfolio based on Investing and Trading strategies. Check out these threads and join the discussion:

Investing strategy based on dividend growth

Trading strategy based on Graham principles.
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Aug 4, 2014
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@Thalo , I agree with you in principle, and posted similar questions myself in Rod’s thread. It boggled my mind why would working people who don’t need additional income, especially high earners, choose to pay higher taxes on the dividends that they don’t need, potentially underperforming even the basic 60/40 balanced portfolio? Why not go for growth instead - and pay lower capital gains taxes in retirement when they start withdrawing for income? I ran a test dividend portfolio that underperformed HXT (that I held in the non-reg account), and thought we’d start buying HGRO or HBAL once our registered accounts are maxed out and we start adding more to the non-reg (didn’t intend to have more than 10% allocated to Canadian equities)

But now that I retired and actually ran some numbers at taxtips.ca (for 2020 in Ontario), I could see how dividend tax credit is beneficial for low income earners/retirees. Even with current 50% capital gains inclusion rate, the difference is substantial. For example, a person with 30K income (25K from employment and 5K from HISA/GIC interest) would pay $4,818 in taxes (10.98% tax rate) If they collect dividends on top of that, they’d actually pay less tax! But more for capital gains:

25K employment income, 5K interest: $4,818 (10.98%)
+5K dividends: $4,525 (8.57%)
+10K dividends: $4,071 (6.37%) -747!
+15K dividends: $4,335 (6.25%)
+5K capital gains: $5,319 (10.84%)

I ran a bunch of scenarios, mostly for RRSP withdrawals (as this is what I’ll be doing) - and yep, up to ~35K of Income additional dividends reduce taxes, while capital gains increase them. At 45K (42K RRSP withdrawal, 3K interest) the taxes would be higher, but 10K of extra dividends would result in the same tax as 5K of capital gains, ~7.5K, ~$600 more than without either.

So, long story short - if the rumours of the government increasing capital gains inclusion rate in the future materialize, the difference between taxes on dividends and capital gains would get even larger. I know that one shouldn’t let the tax tail wag the investment dog. But if paying $5-$10 in commissions for having to sell 5K-10K of say all-in-one ETFs (let along several positions) to generate supplemental income is “too much” for some, $500+ difference in taxes on top of that is a serious enough consideration for me.

Would love to hear yours and others thoughts on this aspect of dividend investing.
Last edited by freilona on Aug 15th, 2020 10:29 pm, edited 2 times in total.
Deal Fanatic
Jul 1, 2007
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Instead of paying an effective dividend tax rate (usually a bit higher than capital gains, in most provinces) on the whole amount of a dividend, why not simply let the company keep the cash and sell a portion of your shares, where you're only taxed on the gain?
Money Smarts Blog wrote: I agree with the previous posters, especially Thalo. {And} Thalo's advice is spot on.
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Aug 4, 2014
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Thalo wrote: why not simply let the company keep the cash and sell a portion of your shares, where you're only taxed on the gain?
Sorry, @Thalo , I’m a practical person - and looking for practical solutions (ideally, implementable in my lifetime, so not involving all-Canadian anti-dividend movement to “let” companies catch up on the new sentiment and change the way they’ve been operating for tens or even hundreds of years :))
[OP]
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Nov 9, 2013
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Edmonton, AB
I index and dividend invest, as I see pros and cons to both.

Personally I think index investing will be very effective long term, and it's a great way for the investor to get out of their own way, but I find it very boring.

So, I stock pick for fun. I enjoy learning about companies and following along and making decisions that will (hopefully) create wealth. If I suck, well, I still have my index port!

Given the inherent risks in stock picking I need to create ways to manage my bias. My biases are I sell too soon and I have fomo. Thus, if I buy a growth stock that shoots up I'll want to sell it. If it keeps going up, I'll want to buy back in, especially if I have no conviction.

How do I create conviction? By looking at something other than price, by looking at something that's long term orientated, and by trying to ignore the whims of day to day price change. For me, dividends are the perfect way to manage my behavioural biases.

Companies that pay dividends, especially those that grow their dividends, tend to be well established and entrenched - this leads to profits and positive cash flow. Aka they are not speculative. Their management tends to be prudent capital allocators (there's empirical evidence to show dividend paying management does better with acquisitions than non dividend paying management) which bodes well for the long term. As dividend are declared monthly or quarterly, I only need to check one number on at most a monthly basis (dividend payment), so I don't need to deal with the whims of day to day price movement.

In reality, I use dividends as an exclusion criteria - if it doesn't pay a dividend then it's not well established enough and worthy for me to invest in. Yes, I recognize this excludes many fast growing tech companies who would rather re-invest their capital than pay a dividend, but I am ok with that. It's not about seeking brilliance and buying the highest flier, instead it's about avoiding errors and partnering with companies that have staying power. Dividends, to me, accomplish that.
Keep calm and go long
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Oct 1, 2006
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Very interesting post @freilona and congrats on your retirement.

Focusing on capital gains instead of dividends may actual save on taxes. If you receive $5K in dividends you will pay taxes on the "whole $5k". If you sell $5K of your investments instead you will only pay taxes on your gains.

If my investments did not do well and did not grow at all I will pay $0 tax on the $5K. If my investments doubled I will pay taxes on $1250 only (Capital gain: $2.5K * 50%). If my investments increased 5-fold I will pay taxes on $2K ($4K*50%).
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Aug 4, 2014
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Thank you, @Germack :) And yep, that’s what I thought - but nope, that’s not how it works. Dividend tax credit actually REDUCES overall taxes on lower income, while capital gains INCREASE them. Try to look at my examples - or run different scenarios in taxtips and see for yourself. So for withdrawal stage, getting 5-10K in dividends is “cheaper” than in capital gains. I’m talking about quite realistic scenarios: having non-registered account supplement RRSP withdrawals (that are taxed as income) or employment income from part-time work (if I get too bored staying home :))

Upd. Oops sorry replied too fast! Re-read your post and see what you meant, will try to re-run my scenarios depending on different capital appreciation %-age :)
Last edited by freilona on Aug 16th, 2020 12:36 am, edited 1 time in total.

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