Why are some people against stocks that pay out dividends?

[ESRwannabe]

That's great. For someone who enjoys the stock picking, it's a great way to go. For someone who doesn't, the established ETFs are a great way to go.

I agree with that.

I used to mainly use VYM by the way for my taxable investments.

 

[aleabo]

A company that pays a dividend must not have any good ideas on how to take that buck and build more business.

Maybe be company doesn't want to build new cafeteria or arrange more "moral events". They prefer to return money to shareholders.

 

[target2019]

I agree with that.
I used to mainly use VYM by the way for my taxable investments.

As you mentioned in an earlier post SCHD and DGRO are worth considering.

There are several companies in your list I will hold onto, but will continue on my path of simplifying our account.

Do you track and consider the total performance of this portfolio?

 

[garyt]

A while back, someone said that if I'm selling off X% a year, I would eventually end up with only one share of stock (assuming no splits, etc). True, but meaningless. I showed in a simple spreadsheet (or just think about it), comparing a $1,000,000 investment in two companies equal in all other ways, growing 4% a year, but one pays a 4% annual div, the other no div, but I sell off 4% a year. Yes, eventually you are down to one share - but that one share is worth $1,000,000! And obviously would split along the way.
-ERD50

How many stocks work so so equally, though? Take AT&T, there price has actually gone down over the last 10 years or so and has been stagnant for the last what, 5 years? But the dividend has actually increased. You'd be broke taking out that 4% a year compared to the dividend investor who would actually make more money.

 

[LarryMelman]

There are three factors to consider when looking at a dividend paying stock:
1. The dividend yield.
2. The rate of dividend growth.
3. The growth of the stock price.

No stock will excel at all three. T has a high yield (6.8%), low rate of dividend growth (2%/year) and a declining share price in recent years. Extremists will use it as an example of why dividend stocks are bad (or good). But really, T is an odd duck. It is not a "typical" DG stock. It may be included in a dividend portfolio (it is part of mine), or it may not be.

 

[aleabo]

That's now how dividend taxation works. Most people do not seem to get it. Here is how I try to explain it to people. This is simplified to the extreme, standard deduction only, etc.

Imagine that you have a glass cylinder with lines drawn on one side representing the tax brackets on ordinary income (salary, interest, pensions, Roth conversions, distributions from deductible traditional IRAs, etc. Really, everything EXCEPT qualified dividends and long-term cap gains.). For a single in 2020, income is not taxed below the standard deduction amount of $12K. Ordinary income between the lines for $12K and $22K is taxed at 10%. Between $22K to $52K, 12%. Between $52K to $97K, 22%. Etc. Pour all your ordinary income into the cylinder, let's imagine that it's red sand. Add up the taxes on that income. That is the tax on your ordinary income and nothing you do can change it. Every incremental dollar of ordinary income is taxes at its level in the cylinder.

Now turn the cylinder around. On the other side are a second set of lines for the tax brackets on qualified income (qualified dividends and long-term cap gains). For a single in 2020, the rates are 0% below $52K, and 15% above $52K. (Also a 20% CG rate up near half-a-mil.) Pour your qualified income into the cylinder with a blue sand. It sits ON TOP OF your ordinary income. Calculate the tax on the qualified income, based on where the blue sand sits in the cylinder.

Your total tax is the tax on the red sand using the ordinary bracket rates, plus the tax on the blue sand using the qualified rates. The dividend income CANNOT affect the tax on the ordinary income. Really, it's the other way around since again the blue (qualified) sand sits on top of the red (ordinary) sand.

If that analogy makes sense, I hope you can see that dividends cannot "push you over a bracket". That's just NOT how it works.

I do not mean to argue for or against dividends, although I very very strongly believe in them as the foundation of my retirement income. Understanding how taxes work is crucial.

Help me please understand. If I bought stock(fund) in taxable, and it cost $10 per share. Let say in one year it distributed dividend /CG $10. In this case I have to pay taxes for those $10 (20%?) but my cost basis back to $10. Next year it repeats. I'm paying taxes on $10 but my cost bases back to $10.
Next year I'm selling. I'm selling now 3 shares (from previous years reinvest ). Since my cost basis same as purchase price ($10) I'm not paying any taxes. Right? Or not?
Same scenario in 401K/Traditional IRA. I'm not paying any taxes yearly but upon sale. Now I'm selling 3 shares ($30) In this case I have to pay taxes from all $30 and it count as ordinary income.
Is it right scenario?

 

[mpeirce]

How many stocks work so so equally, though? Take AT&T, there price has actually gone down over the last 10 years or so and has been stagnant for the last what, 5 years? But the dividend has actually increased. You'd be broke taking out that 4% a year compared to the dividend investor who would actually make more money.

A total return investor would not be cashing in 4% of that ATT stock each year if they owned it because they are getting their 4% from the dividend. See, the TR investor just takes 4% from wherever. Dividends always roll in first since you can’t ask the company to “please don’t pay me a dividend”. So after that money comes in the TR investor would say “no need to sell any stock since I already have my 4%”

This assumes a simplified situation where ones entire portfolio is ATT stock...

 

[garyt]

A total return investor would not be cashing in 4% of that ATT stock each year if they owned it because they are getting their 4% from the dividend. See, the TR investor just takes 4% from wherever. Dividends always roll in first since you can’t ask the company to “please don’t pay me a dividend”. So after that money comes in the TR investor would say “no need to sell any stock since I already have my 4%”

This assumes a simplified situation where ones entire portfolio is ATT stock...

True

 

[LarryMelman]

Help me please understand. If I bought stock(fund) in taxable, and it cost $10 per share. Let say in one year it distributed dividend /CG $10. In this case I have to pay taxes for those $10 (20%?) but my cost basis back to $10. Next year it repeats. I'm paying taxes on $10 but my cost bases back to $10.
Next year I'm selling. I'm selling now 3 shares (from previous years reinvest ). Since my cost basis same as purchase price ($10) I'm not paying any taxes. Right? Or not?
Same scenario in 401K/Traditional IRA. I'm not paying any taxes yearly but upon sale. Now I'm selling 3 shares ($30) In this case I have to pay taxes from all $30 and it count as ordinary income.
Is it right scenario?

Your description of the IRA scenario is correct.

Only funds distribute CG's. Stocks do not. So the discussion below applies to a hypothetical fund.

In a taxable account, your basis of the original purchase is always $10 per share and never changes. Yes, if there is a $10 distribution after each year, and the NAV at the time of the distribution was $20, then the distribution is reinvested at $10 because the distribution reduced the NAV from $20 to $10. You owe income tax (at the Qualified bracket rate, if the distribution was entirely dividends and/or long-term capital gains) on the $10 distribution. This is obviously a very simplified case.

After year 1, tax is paid on the $10 distribution, and it is reinvested in a new share that also has a $10 basis. Now you have 2 shares, both with $10 basis.

After year 2, if the NAV doubles again to $20, you will have 2 shares worth $20 each. If the fund again makes a $10 distribution, you have $20 of qualified income in year 2. The year 2 distribution buys 2 more shares at $10 each. Now you have 4 shares each with $10 basis. If you sell them at $10, which is your basis, no further tax is owed. Your original investment was $10, your final proceeds were $40, and you paid tax on the $30 of distributions made along the way.

Please note that reinvestment of distributions is not required. But you cannot avoid the distribution being made by the fund, you cannot control the amount, and it is not predictable from year to year. This is perhaps the main reason that I have gone to dividend paying stocks - the dividends are known and predictable.

 

[RetireBy90]

Help me please understand. If I bought stock(fund) in taxable, and it cost $10 per share. Let say in one year it distributed dividend /CG $10. In this case I have to pay taxes for those $10 (20%?) but my cost basis back to $10. Next year it repeats. I'm paying taxes on $10 but my cost bases back to $10.
Next year I'm selling. I'm selling now 3 shares (from previous years reinvest ). Since my cost basis same as purchase price ($10) I'm not paying any taxes. Right? Or not?
Same scenario in 401K/Traditional IRA. I'm not paying any taxes yearly but upon sale. Now I'm selling 3 shares ($30) In this case I have to pay taxes from all $30 and it count as ordinary income.
Is it right scenario?

I would have to agree with the scenarios you crafted but not sure they are a valid or likely case. In a taxable account, you have dividends that are in theory offset by a decline in share price so a $1 dividend each quarter would cause the share to drop $1. In theory. Now that $10 you paid for the stock, would be $9 and you have $1 in cash, but you now have a tax liability for the dividend so you paid tax on $10 when you earned it and now pay again on part of it. Next quarter same thing. In this example every 2 1/2 years or 10 quarters you pay tax on your $10 all over again.

Hrmmmm

 

[aleabo]

I would have to agree with the scenarios you crafted but not sure they are a valid or likely case. In a taxable account, you have dividends that are in theory offset by a decline in share price so a $1 dividend each quarter would cause the share to drop $1. In theory. Now that $10 you paid for the stock, would be $9 and you have $1 in cash, but you now have a tax liability for the dividend so you paid tax on $10 when you earned it and now pay again on part of it. Next quarter same thing. In this example every 2 1/2 years or 10 quarters you pay tax on your $10 all over again.

Hrmmmm

Sorry I didn't get. Why do I have to pay tax on $10? In your example $10 pay $1 dividends each quarter and price drops accordantly. Assuming price not changing by end of the year I have stock that cost $6 and $4 in cash. Tax paid on $4 dividends. I don't see how $10 come to picture again.

 

[RetireBy90]

Sorry I didn't get. Why do I have to pay tax on $10? In your example $10 pay $1 dividends each quarter and price drops accordantly. Assuming price not changing by end of the year I have stock that cost $6 and $4 in cash. Tax paid on $4 dividends. I don't see how $10 come to picture again.

In my example, after 10 quarters you would have received $10 in dividends. We could use your example, after a year you have 1 share and $4 but the $4 is taxable.

 

[ownyourfuture]

I think they serve a purpose, especially for those who already have a huge amount of money to begin with. Often, dividend paying stocks are the larger established companies that don't have a lot of price appreciation.

Very good point(s)
Johnson & Johnson is a perfect example of what you pointed out in the 2nd sentence. I bought my 1st 100 shares in 2002 @ $48

It's now trading around $160 & there hasn't been any stock splits.
So capital appreciation wise, it hasn't done that well. I look at it as an annuity that pays me a little over $600 every 3 months.

I also understand why capital appreciation is more important than dividends for you at this point.

 

[ERD50]

... I also understand why capital appreciation is more important than dividends for you at this point.

Neither one is more important than the other. They are both money, and money is fungible (caveat for any differences in taxation, which generally favors capital appreciation in a taxable account).

-ERD50

 

[triangle]

Sorry I didn't get. Why do I have to pay tax on $10? In your example $10 pay $1 dividends each quarter and price drops accordantly. Assuming price not changing by end of the year I have stock that cost $6 and $4 in cash. Tax paid on $4 dividends. I don't see how $10 come to picture again.

$10 would still be your per share cost basis, so if the share price had declined to $6 on the day you sold, you would have a $4 loss. Where this loss would offset other gains in your portfolio to reduce your tax burden. In this simplified example your net gain (income) would be $0 since the $4 loss offset the $4 in dividend income, so you would owe no taxes.

When dealing with funds, keep in mind that not all payouts are qualified dividends. Some might be classified as non-qualified and get taxed at your marginal rate. Some might be classified as ROC (return of capital) which would not be taxed but would reduce your cost basis. Using your example above if that was a $1 ROC each quarter instead of a qualified dividend, it would be considered "your original investment" so it would add $0 to your total income. Likewise when you sold, the tax basis of your share would have dropped to $6 so again there would be $0 gain/loss. You would have effectively accomplished nothing but buying a share and getting your original investment back.

 

[Koolau]

I've only owned a few actual single stocks in my life. My largest single-stock holding often increases its dividend which I look at as recognition of success - especially since the company continues to do very well. Probably the only reason I have the stock is that it was a stock-option by Megacorp and I knew how successful Megacorp had been for the 30+ years I was there. (Dance with the one who brung you.)

Based on my basis, the stock is yielding maybe as much as 20%. Of course, since the stock has risen dramatically in price over the years, the official dividend yield is perhaps a tenth of that now (around 2% +/- 1%). I don't think too much in terms of dividends or not since most of my stock is in funds. Still, it's nice to watch Megacrop still (going) crazy, after all these years - apologies to Paul Simon. YMMV

 

[stephenson]

Yes, I know it’s not a fixed income investment, but I so tired of reading of 1% that I put part of my FI component in ATT.

The share price is relatively stable and dividend is about 7%.

I know, I know ...

 

[Dash man]

There are three factors to consider when looking at a dividend paying stock:
1. The dividend yield.
2. The rate of dividend growth.
3. The growth of the stock price.

No stock will excel at all three. T has a high yield (6.8%), low rate of dividend growth (2%/year) and a declining share price in recent years. Extremists will use it as an example of why dividend stocks are bad (or good). But really, T is an odd duck. It is not a "typical" DG stock. It may be included in a dividend portfolio (it is part of mine), or it may not be.

T has a pretty poor dividend coverage ratio with earnings, too. If T has a hiccup, they'll be cutting the dividend, and we all know what happens to the stock price when a dividend is cut.

 

[stephenson]

Dash man - agreed, but that hasn't happened ... yet ...

ATT seems to actually be on the mend

 

[marko]

Late to the discussion, but for the past 15 years, we've been living quite nicely off of MF dividends. Haven't owned individual stocks for years and years.

That's until this past year-end dividends where we've seen about a 25% Covid related drop; this is coupled to about a 5% drop the year before.

One fund in particular has been disappointing in both income AND growth and stood out from the rest.

So........I've been slowly divesting from that fund, kept my MFs that are growth oriented and have been buying up some dividend aristocrat stocks (along with one that's paying me 10% to take a little risk). As such, it should get me back in line with our income expectations. With bonds sliding, I've moved a bit north of 60/40...more like 68/32 but that's ok.

 

[LarryMelman]

Late to the discussion, but for the past 15 years, we've been living quite nicely off of MF dividends. Haven't owned individual stocks for years and years.

That's until this past year-end dividends where we've seen about a 25% Covid related drop; this is coupled to about a 5% drop the year before.

That's the problem with MF dividends. They are totally unpredictable.

The stocks in my taxable account pay me a "known" dividend stream every year. Most raise every year. Cuts and freezes happen, but very rarely.

I still have some growth-oriented MF's that I've owned since the 80's and 90's. The distributions vary wildly every year. I would not want to count on them.

 

[disneysteve]

That's the problem with MF dividends. They are totally unpredictable.

The stocks in my taxable account pay me a "known" dividend stream every year. Most raise every year. Cuts and freezes happen, but very rarely.

I still have some growth-oriented MF's that I've owned since the 80's and 90's. The distributions vary wildly every year. I would not want to count on them.

I think that's true of the growth-oriented funds. I've certainly seen those wild swings in my own growth MFs.


The dividend-oriented funds are more predictable since they are designed specifically to generate dividend income. I'm in VYM personally for that purpose

 

[Lawrencewendall]

Ok. This thread got me thinking about my own portfolio. I went back 4 years (not cherry picking but that's when I REALLY started tracking stuff)

My dividend portion of my portfolio did 37.17%, reinvesting all dividends. Some funds reduced/suspended dividends due to Covid and other factors (poor management/bad sector)

My small and Mid cap index fund (TSP S Fund but equivalent to FIDO IJH and IJR) pulled 67.69% and that is with me pulling out about 100k since 2019.

Makes me reconsider where I will put next year's conversions (another 3 years until I can access the conversions).

I know the last 4 years may not be indicative of the next 4 years but I was surprised on the performance difference. If I'm calculating something wrong, please let me know.

 

[disneysteve]

My dividend portion of my portfolio did 37.17%, reinvesting all dividends. Some funds reduced/suspended dividends due to Covid and other factors (poor management/bad sector)

My small and Mid cap index fund (TSP S Fund but equivalent to FIDO IJH and IJR) pulled 67.69% and that is with me pulling out about 100k since 2019.

Makes me reconsider where I will put next year's conversions (another 3 years until I can access the conversions).

I know the last 4 years may not be indicative of the next 4 years but I was surprised on the performance difference. If I'm calculating something wrong, please let me know.

The dividend stock portfolio will likely under-perform the growth stock portfolio almost by definition. That doesn't mean either one is right or wrong. They serve different purposes and carry different levels of risk.


There's also a different mindset behind each. Would you rather have a steady automatic income stream or would you prefer to have to actively decide what holdings to sell and when to access cash as needed? Again, neither is right or wrong. And many people do some combination of both.

 

[Lawrencewendall]

The dividend stock portfolio will likely under-perform the growth stock portfolio almost by definition. That doesn't mean either one is right or wrong. They serve different purposes and carry different levels of risk.


There's also a different mindset behind each. Would you rather have a steady automatic income stream or would you prefer to have to actively decide what holdings to sell and when to access cash as needed? Again, neither is right or wrong. And many people do some combination of both.

I guess. I'm sitting about 50% in each. Can't touch most for at least 3 years so we'll see how it goes.