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Death to Dividends

Michael Flack

KIPLINGER’S HAS TOUTED using dividends to “Fund 20 Years of Retirement,” Forbes insists they’re useful “For Sleeping Well At Night During Turbulent Times,” and Seeking Alpha declares “I’m Living The Retirement Dream, Paid With Big Dividends.”

Morningstar has an entire monthly newsletter devoted to the subject of dividends. I even vaguely recall HumbleDollar praising the virtues of dividend-paying stocks.

Investing in such stocks is perhaps the oldest investing meme in the world, most likely invented right after the second company went public. It sounds like a great idea. Discard all stocks that don’t pay a dividend, analyze each remaining stock’s dividend “track record,” invest in ones that have a history of increasing dividends over time, and—voila—success is apparently assured.

If folks want to invest their money this way, so be it. To me, it’s akin to religion. Whatever people want to do in their private life is fine with me. But when they start foisting their ideas on others, something must be done.

Investing in dividend-paying stocks is lunacy for two reasons. The main reason is that there are zero studies that show this stratagem can beat the market. This is the acid test of investing. A few years ago, while enjoying a free lunch, I listened to a professional money manager tout his dividend-paying stock strategy.

His had the added twist of only investing in stocks that had a dividend yield within a certain range. Not too low, where the dividend was insignificant, and not too high, where the dividend was overstretched. But in the middle or, as Goldilocks might say, “just right.”

I subsequently investigated and could not find a single study confirming that investing in dividend-paying stocks can beat the market. Not one. If a strategy can’t beat the market, then it’s useless and shouldn’t be followed, let alone advocated.

The second reason for not investing in dividend-paying stocks is that it’s tax-inefficient. Every year, if you hold these stocks in a regular taxable account, you have to pay taxes on your dividends and have no control over their timing or amount.

Years ago, I had a dividend-paying golden child. Year after year, he raised his dividend until one day, after a corporate restructuring, he stuck me with a colossal capital gains tax hit and then subsequently cut his dividend in half.

Proof that investing in dividend-paying stock is lunacy is that its antithesis—investing in stocks that don’t pay a dividend—is incredibly appealing. I have no evidence that this Buffett-esque strategy will beat the market, but you won’t pay any tax until the year of your choosing.

Another dividend-loving Kiplinger’s article mentions the requirement to get “rid of stocks that suspend or cut their dividends.” What? So, when a company suffers a financial reversal, it should do everything possible to keep paying the dividend? I don’t know about you, but when I’ve faced some fiscally trying times in my life, I didn’t maintain my spending level and I certainly didn’t increase it a little bit more.

There may be ways to beat the market. I’m still looking for one myself and, until I find it, I’m sticking with index funds. If you have a strategy, I’m all ears. But please provide some evidence that substantiates your claims. As author Christopher Hitchens said, “Extraordinary claims require extraordinary evidence.”

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