Debunking the Myths of Dividend Investing - Physician on FIRE (2024)

Share this post:

22 thoughts on “Debunking the Myths of Dividend Investing”

2. Pingback: How Can You Ensure You Have Taken Care of Yourself Before You Take Care of Others During the Coronavirus Pandemic?

3. Subscribe to get more great content like this, an awesome spreadsheet, and more!

4. Pingback: Investment Income & Taxation: Intelligent Design or Jurassic Park? — Physician Finance Canada

5. Pingback: Why This Index Fund Investor Purchased an Individual Stock -

6. I’m so glad to read this text. It’s exactly what I think and do with part of my portfolio.
   The FIRE community can be a pain sometimes and they don’t accept whomever doesn’t follow exactly that they preach which is indexing with Vanguard. It became almost a religion.

   I’m so happy to read a different approach to validate what I’ve always believed. If you never have to sell a share to finance your retirement and because of that my total return is 1% less due to tax drag so BE IT !! I’ll sleep well at night knowing that I don’t need to worry about selling shares if the market tanks !!!
   congrats PoF for these excellent points

   Reply

7. Great article, thank you for addressing these myths. Dividend investing is simple, and provides a steady income stream. It is the ideal form of passive income and can fund your entire retirement if done correctly. Thank you for your article!

   Reply

9. Dividend investing is really just value investing. The problem is only about 40% of stocks pay dividends, so you are missing out on all the non dividend paying value stocks. If you want to invest in value stocks (with higher expected return relative to the broad market) it makes more sense to buy a value ETF. Ignoring non dividend payers results in a less diversified portfolio, which is therefore riskier than a more broadly diversified portfolio, not to mention less tax efficient due to the higher yield. The other issue currently with dividend payers is that because of low interest rates there has been a reach for yield which has driven up the price of dividend paying stocks so much that they now have valuations higher than the broad market, so therefore have lower expected returns going forward.

   Reply

10. Good article. I’ve been dividend growth investing since 2014 and plough in fresh capital on top of dividend reinvestment and dividend raises. I’m on track to break $100k if dividend income this year, and this is in addition to rental income and working a day job. My total dividend payment growth rate has averaged 18% a year and I’ve had a bad year with 5% growth due to several dividend cuts in energy but that was offset with two years at 22% and 23% growth. This is in an after tax portfolio. I have another $7-8 k per year in dividend income in a pretax portfolio.

    You don’t have to do the same as that leaves less competition. I prefer buying my shares at a lower price.

    Drowning in income is actually fun and I don’t mind paying taxes at the low rate it is charged. I’m in my mid 40’s so as I get up there in years more of this cash flow stream will go towards charitable endeavors.

    -Mike

    Reply

11. Does anyone know of a good site that is able to show a stock or fund with total return (ie, dividend reinvestment) vs just the nominal price over time?

    Reply

12. I love dividends, and I do have a portion of my stock investments allocated to dividend stocks. I don’t have the time, desire, or personality to directly own real estate, but I do enjoy researching stocks . While I’m far from an expert, I have become a more disciplined and focused investor because of all the research I have done.

    There are a few reasons that appeal to me personally that haven’t already been discussed. First, I like the fact that most of the dividend paying stocks increase their dividends at a rate faster than inflation (6-7% annual increases for what I currently own). I hope to be able to have a substantial income one day from dividends, and the fact that I should be able to increase my purchasing power every year is very appealing to me.

    Second, I don’t need to live on the dividends currently, so I pool the dividends and purchase stocks that I feel are undervalued based on historically low PE ratios and historically high yields (I use additional screens as well but those are a good starting point). This gives me that opportunity to be buying ever increasing numbers of shares of undervalued stocks that will, hopefully, “revert to the mean” at some point in the future.

    Third, I can focus on my income instead of the stock price. Dividends tend to be relatively stable while stock prices can fluctuate wildly. I, literally, have no worries about a drop in stock price because the underlying income is unchanged. In fact, I find myself actually hoping that the stock price drops, so I can have the opportunity to buy the stock at a higher yield.

    Lastly, dividend investing seems to provide some insulation against “sequence of return risks” that can happen immediately after retiring. Since I can have a stable income without selling the stock, a drop in the stock market early in retirement doesn’t worry me as much. My income would be unaffected, and the money generating stocks underneath would still be intact. At least, that’s my impression. Again, I’m not an expert, so if you think that’s an incorrect assumption, I’m happy to learn from this community.

    Of course, as with any style if investing there is risk. My goal is to mitigate that risk by buying stocks in different sectors and not having more than 5% of my dividend income coming from any single stock. Although my goal is to hold a stock forever once purchased, I also have a very few reasons why I would sell a stock that will hopefully protect against downside risks.

    Just my thoughts on this…

    Reply

14. 1. Actively managed “funds” are not dividend paying “stocks”. Actively managed funds have charges come rain or come shine and therefore drag the return.

    2. The idea you can’t beat the market is silly. If you bought AMZN and S&P 500 in 1998 S&P 500 is up 300%, AMZN is up 8000% This is known as a beat. If you bought BRK.B in 1996 it’s up 1000% S&P500 is up 420% since 1996 aka BEAT.

    If you own S&P 500 you own a dividend paying stock equivalent . S&P had paid 2% in dividends since Dec 1999. S&P growth has only been 3.4%/yr since Dec 1999 ex dividends till Dec 2018. S&P 500 with dividends reinvested has returned 5.4%/yr since Dec 1999. I use that time frame since it covers the last two market peaks and 2 recessions. Bonds have returned 3.9%/yr since Dec 1999.

    I look at dividend stocks as a kind of diversity. S&P paid 1.9 to 2% return every year regardless of asset price. At market peak in 2007 to market trough in 2009 the S&P dropped 59% of it’s value but still paid about 2%. If reinvested that’s “buy low” automatically implemented. It turns out for a couple years the S&P returns have not been broad based. about 100 of those stocks were in a bear market even when the index was roaring and another 100 were under water but not bear market. The FANGS and about 30 other stocks made up the difference. So dividend investing has it’s place. What I don’t like about dividend investing is people get too cute with dividend paying stocks and always go for the gold which tends to concentrate sectors.

    There is a trading strategy that has beat the market by 100% since 1999 that’s called Dogs of the Dow. The strategy only buys the 5 cheapest highest yielding stocks in the dow and holds them for a year so you are ranking on price and yield and it’s a value play on a specific universe of stocks namely the DOW. The DOW are the best run companies in the world and when they stop being best run they get kicked out. That’s a form of risk management. It is not expensive since you make a $5 trade on 5 or so stocks once a year. Sometimes you keep the same stock fore 2 years so you don’t trade just reinvest the dividends. I did an analysis and found 40% of the return was due to dividends and dividend reinvestment. Stick that in your bogglehead index investing pipe and smoke it. There are a lot of relatively safe ways to make money beside the “three fund” bogglehead approach. You want to control your risk even more set up a 60/40 DotD/bonds portfolio. The 5 stocks 12% each adding up to 60% and VBMFX at 40% gives an expected 10% return at 9% risk. For a bogglehead 3 you can expect 6.2% return at 13% risk.

    Reply

15. Personally, I love dividends. They are right up there with rental income on my favorites list.
    I don’t write about it often because I get tired of all the arguing. I see that there are pros and cons. To me, there are a lot of benefits. Some of which you mentioned.

    I know retirees who have done this and they don’t fear running out of money.
    High dividend yields often indicate value stocks which outperform in the long run.
    It allows a higher percentage of equity investing without much stress over volatility.
    I don’t cook the goose. I enjoy the golden eggs it drops.
    I don’t have to decide when to sell shares. The dividend checks just come to me.
    I don’t have to sell after a market decline and subject myself to SoR risk.
    Dividends and dividend yields don’t drop as much as the overall market – even in recessions.
    Dividends and the underlying stocks tend to increase over time and produce more cash flow.
    I could live off all the dividends that I get right now. People can argue with that all they like.
    For now, I’m off to the bank to deposit a dividend check. Literally.

    Reply

16. I may be asking a dumb question but one reason index funds are popular is that many studies have shown they beat actively managed funds most of the time. It isn’t really arguable because the data is public. So can’t the dividend stock debate be settled the same way? Just compare the average dividend fund performance to the index fund performance? It would stand to reason that dividend fund managers would know even more about how to screen stocks than you since you are a private equity guy now and they pick dividend stocks for a living. So if dividend stocks outperform when total return is measured and if normal investors are going to never match a paid professional then it ought to be duck soup for actively managed dividend funds to slaughter index funds over time. And maybe they have. I searched Google and could not find a single comparison of actively managed dividend funds versus index funds. I think that might add some insight to the debate, have you seen any comparisons like that?

    Reply

    • There are lots of studies that show this data annually. Larry Swedroe at ETF.com shares this information regularly.

      Best,
      -PoF

      Reply

17. I love dividend investing and I engage in it on a very small scale relative to the bulk of my net worth. One problem with almost every dividend investing methodology I’ve encountered (including dividend growth investing): What happens when, during a market downturn, one or more of the components of your income portfolio cut their dividend? Are you stuck losing a portion of your income stream, having to sell into a capital loss, AND having to come up with more investible assets in order to replace the lost income? Because it seems like that’s the major achilles heel of every dividend investing style on the planet. I don’t care how great your selection techniques are or how advanced you feel like your skills as a stock picker have become, you’re vulnerable – and we’re in an era where even the most vaunted and venerable managers are failing to keep up with the indexes whether we’re in the midst of a major bull market swing to the upside like in 2017, or we’re in the throes of a volatility spike like we have been through the last two months.

    Of course, mutual fund managers charge administrative costs reflected in the fund’s expense ratio. If you’re going it alone, these expenses are better reflected in time, effort and worry.

    The tax treatment of dividends depends on whether you are investing in securities that pay qualified or unqualified dividends. The vast majority of dividend equities pay qualified dividends, which means you’re taxed at the long-term capital gains tax rate – the same tax rate you’d be taxed at if you sold a few shares of an index fund to create portfolio cash flow yourself.

    Let’s accept the Ibbotson research suggesting that 90% of a portfolio’s returns come from asset allocation alone – which can be achieved using indexes and low-cost products across various asset classes.

    How much time, effort and worry do you want to invest in that remaining 10 %? How much is maximizing that 10% really worth to you?

    Those are questions that MUST be answered before one becomes a dividend investor or any kind of investor more active than a simple, market-based index fund investor.

    Reply

18. 

19. I am looking to have my dividend portfolio replace at least one paycheck per month as part of my overall FIRE plan. With $300k in, I am more than halfway to my goal. Develop a plan that works for you and then stick to it, it is too easy to try and chase returns. Disciplined dividend investing is the sign of mature FIRE!

    Reply

20. “I recently went to Target and they look to be doing just fine to me now. Retail-apocalypse? I think not.”

    Equals

    It’s snowing now so global warming is a lie.

    I’m not saying that there is not a reasonable, evidence based, argument to be made for dividend investing, but this guy seems to just have more hot air (or ink as it were) than anything else.

    Reply

21. Thanks POF for posting this post. Thanks Millionaire Mob for your view. It’s always great to see multiple sides of the story and various interpretation on investing. Love it.
    And since I can’t decided what I like best, we still have Index Funds, dividends shares and real estate 😉

    Reply

22. I am also confused about the concept of “compounding” in reference to dividend payouts. Dividends are simply returning a part of your investment to you, maybe when you don’t want it.
    Isn’t investing in large cap/dividend paying Stocks dangerously undiversified?
    If these Stocks are so highly sought after, isn’t this reflected in a higher price?
    Are dividend pay outs always the best use of capital by the company?

    Most of the desire for dividends is behavioral. The buyer feels he/she is constantly being “rewarded” for buying the Stock.

    Reply

    See Also

    20 hedge-fund dealmakers who are beating VCs at their own game by pumping billions into the world's hottest private companies

23. 2 words:

    Uncompensated risk.

    Reply

24. I always love articles that give a counter point view to the view I currently have. If you get information from both sides you basically can make your own decision, much like informed consent is supposed to do for patients about to undergo a procedure.

    I do get some of the risks of index investing. Even a total market index fund is heavily weighted towards the larger companies just because of market capitalization. For instance the Vanguard 500 fund and the vanguard total stock fund are nearly identical (and I use that as my tax loss harvesting exchange equivalent) because the top 500 companies dominate the market cap so much that it skews the total index to have very similar holdings.

    I remember when I got my free analysis from Personal Capital they warned me of being overweighted in particular sectors (like Millionaire Mob said, Tech heavy). Their counter was to do sector investing and try to spread the same allocation over the 10-12 sectors in the market. I have done this manually using Vanguard sector funds myself when I feel underweighted in a particular sector).

    Index funds typically give a high 1% to low 2% yield. I am curious what the yield is you typically get when you solely focus on dividend investing.

    Reply

    • I can’t speak for the author, but I invest a portion of my money in dividend paying stocks. That portion of my investments generates about a 3% yield and the dividends increase at an annual rate of nearly 7%. I think you could easily generate 4% if you desired while still maintaining good diversity and low risk. I know of people who try to push 5%, but they have to get a little too heavy into REITs, telecoms, and utilities in my opinion. My yield of 3% is a little low because I have several stocks with a low yield that I believe have significant opportunity for future growth (example Disney yielding 1.54% and Visa yielding 0.71%)

      Kindest,

      Reply

25. Thank you. Thank you. Thank you.

    I DO believe in a total return approach. That said, I have been an investor with Vanguard Wellington fund for almost three decades now. When I started investing dividend investing was popular and low P/E ratio stocks made good sense. Jack Bogle, John Neff, Ben Graham, Ed Owens ( Vanguard Health Care funds former manager), and even Buffet all believed in value investing.

    I am not trying to beat the market, only trying to come as close to those returns with the lowest amount of risk that is right for me, keeping a “margin for error.” As well as instant diversification, constant re-balancing (no need to sell and re-balance myself) and keeping things as simple as possible for my heirs.

    Reinvesting of dividends over 25+ years has allowed us to build shares (and wealth ) even on a modest income.

    As always, YMMV…

    Reply