5 Reasons to Avoid Dividend Stocks

As highlighted in an earlier write-up, dividend stock/portfolio or dividend income investing can be a great means of building an income stream or growing your portfolio. However, one should be aware of the potential risks or disadvantages of doing so as well.

Opportunity Cost

One obvious disadvantage of dividends is the opportunity cost. Sometimes, while you, as the investor are being awarded part of the excess cash flow from the business’s operations, you have to wonder, could this cash have been put to better use? Rather than paying us 7% as an annual dividend payout, what would be the outcome of the business (and in turn, me as the investor), if this 7% is instead reinvested into the operations or growth of the business?

forcing a taxable event

The moment you receive a dividend, you will realize income. And by law, you will be required to report this income next time you file your taxes. These proceeds will be tacked on to your ordinary income, and ultimately you’ll be subject to pay income taxes based on your overall income. Why put yourself in a situation where you’re forced to pay taxes? (Versus perhaps investing in a growth stock that pays virtually no dividend but appreciates and is only taxed if you sell the stock)

Dividends are an Illusion

The problem with many dividends is that they aren’t truly income. There may be a psychological factor associated with dividend stocks and dividend portfolios based on prospects and historical performance. However, the fact of the matter is, when you receive a dividend, your net worth doesn’t necessarily increase. If a $30 stock is set to payout $0.50 in the form of a dividend, for example, your balance during the event of the payout isn’t $30.50. It remains $30, because prior to you receiving $0.50 in the form of a dividend, the price of that $30.00 stock essentially diminishes to $29.50. So while you may be under the impression that you will have 1 stock worth $30, and a cash balance of $0.50 following the dividend payout ($30.50), you will actually have 1 stock worth $29.50 and a cash balance of $0.50 ($30.00). This, in connection to the above point about forcing a taxable event, makes many investors shy away from dividend stocks. Why receive dividends, which you later have to pay taxes on, especially when your portfolio value doesn’t really appreciate? (Unless the stock outperforms the dividend payouts)

Dividends are not Promised

Although many investors and retirees opt to use dividends as a means or psychological avenue of income security (to ultimately replace their jobs or live off of), the unfortunate news is that they aren’t always guaranteed. Although past performance and payouts may be a good indicator of future prospects, companies are not obliged to guarantee future payouts. In fact, many companies can and have eliminated, postponed or cut dividends for reasons such as poor company performance. During the Coronavirus Pandemic of 2020, for example, we witnessed some of the biggest companies cut dividends, such as Wells Fargo, Dick’s Sporting Goods and Estee Lauder. Still, if you prefer to invest in dividend stocks, it may be an option to shortlist those that are considered Dividend Aristocrats.

under-performance

One other disadvantage of dividend-based portfolios is that the market may outperform them. Especially for portfolios that do not employ Dividend Re-Investment Plan (DRIP) plans, you will tend to have stagnant cash from dividends in your portfolio rather than maximizing and fully allocating the capital to work for you at all times. This may prove to be a significant opportunity cost over a long period of time.

Ultimately, there is no right or wrong answer as far as whether or not one should employ a dividend investing portfolio strategy. Hopefully these write-ups equipped you to weigh the pros and cons yourself based on your specific needs and scenario. Thank you for your time and for

…paying…

attention.