Make The Case for Dividend Investing

[thef0x]

I've done a bit of steel-maning research and one variable I had not considered was extracting value today being strategically advantageous to the early retiree vs growing value for tomorrow. I think this would influence when in one's life one would more heavily weight dividend investing in their portfolio (same deal w fixed income), but for us folks who have early retired in our 30s or earlier, I also believe growth is incredibly important for the longevity of maintaining a 3-4% SWR.

I'd love to hear everyone's arguments for dividend investing.

[Salathor]

Here's my philosphy:

Imagine I offered to let you buy a company that I ran that made $1,000,000 per year with no work on your part. The only catch is that it's a C corp, you aren't allowed to hire yourself by it, and it has stipulations that it will never pay out any revenue to the owner. What is the value of that company?

Practically nothing. There is $1m of revenue there but you are never allowed to access or benefit from it. Yes, there is some value in reselling it to another company that might make use of its product lines or something, but at some point that becomes prohibitive. Who is big enough to acquire Apple?

I firmly believe that dividends (or the prospect of future dividends) is the only true drive of stock valuation. Everything else is speculation.

Growth is important, but it's speculative. How do you know what PE multiple someone will be willing to pay for company X at some point in the future? WHY would they pay a greater multiple than now?

Good dividend investing also results in growth. My stable portfolio of indexed dividend stocks are growing earnings at ~15% per year, and dividends by about the same amount. I actually received 18% more income this year than last year. Yes, my portfolio has gone up more than that due to PE expansion, but I don't know how long the market's risk appetite will be high. What if next year they're only willing to offer 18x PE?

EDIT: "dividend investing" as a classic idea does not mean buying janky 8%+ yielding covered call etfs. It means buying good companies that generate revenue, that are GROWING that revenue, and that distribute it to shareholders. Dividends stocks should grow.

[loutfard]

I'd love to hear everyone's arguments for dividend investing.

I can give you my argument against dividend investing: I shoot myself in the foot if I do. 30% tax on local dividends and 40.5% best case on foreign ones, versus 0% on capital gains.

Side note. Bond taxation is similar, except the capital gains are also taxable. Which is why I park a small reserve in a synthetic money market fund containing only shares as assets and swaps.

[purple]

I can give you my argument against dividend investing: I shoot myself in the foot if I do. 30% tax on local dividends and 40.5% best case on foreign ones, versus 0% on capital gains.

Side note. Bond taxation is similar, except the capital gains are also taxable. Which is why I park a small reserve in a synthetic money market fund containing only shares as assets and swaps.

Came here to say this. If your country has a progressive tax rate, it gets brutal in high income bracket. ***IF*** you are still employed or otherwise receiving high income.

[loutfard]

Came here to say this. If your country has a progressive tax rate, it gets brutal in high income bracket. ***IF*** you are still employed or otherwise receiving high income.

The preferential 40.5% foreign dividend tax are is flat tax from the first cent.

Progressive income tax is levied on most other income sources. Top bracket from 48320€: 53.5% excluding social security contributions.

[chenda]

I can give you my argument against dividend investing: I shoot myself in the foot if I do. 30% tax on local dividends and 40.5% best case on foreign ones, versus 0% on capital gains.

Are there not tax free savings accounts where you are ?

[loutfard]

Are there not tax free savings accounts where you are ?

The main ones:
- withholding tax reduction for all individual stocks combined up to 240€ net per adult per year. 800€ of dividend free of Belgian withholding tax. You still pay the foreign withholding tax.
- pension savings account: max ~1k€/year from net income. Only specific expensive Belgian funds qualify. Total expense ratios 1.5% and up. A subsidy to the banks basicly. 30% initial personal income tax refund, 8% final tax on gains. Not worth it unless over the age of 55.

Belgium is not comfortable for accumulating an investment portfolio, but _very_ comfortable for the distribution phase. Just sell accumulating etf's and pay 0.12% of transaction tax. No capital gains tax or income tax.

[chenda]

@loutfard - interesting, Belgium seems somewhat unusual in this regard.

I'm a big fan of dividend investing. Select a dozen or so blue chip FTSE 100 or similar companies, with a long history of high yields, diversified across various boring sectors. Reinvest the dividends for accumulation, spend then for retirement, or switch between the two. Job done.

For full disclosure I don't yet do this, but it's my plan for if/when I come to invest in shares.

[thef0x]

@Chenda, I guess one of the driving questions I mean to ask is: why dividend investing vs XYZ investing (growth, risk parity, whatever). I'm wondering what's drawing you specifically to dividend investing vs other potential strategies, if you'd be interested in weighing in.

[2Birds1Stone]

Big ERN did a 3 part sub series on dividend investing as part of his infamous SWR Series.

"Can a high dividend yield generate better investment outcomes?
Part 29, Part 30, and Part 31 all deal with the widely held misconception that we can easily save the 4% Rule if we were to increase the dividend yield to a level close enough to your 4% annual withdrawal rate. Live off your dividend income, avoid ever selling your principal at depressed valuations, and shield your annual withdrawal amounts from Sequence Risk, right? It certainly sounds intuitive and I was intrigued enough to research this option and hoped it could lower Sequence Risk. People in the FIRE community call it “Yield Shield,” but that label is extremely deceptive because it doesn’t work reliably. It would have backfired really badly during the 2007-2009 bear market and again in 2020. Instead of shielding yourself from the downturn, you would have aggravated the Sequence Risk. Sticking to a balanced portfolio with equity and bond index funds is best."

https://earlyretirementnow.com/safe-wit ... te-series/

[frommi]

That highly depends on where your dividends come from. In his articles he writes that the dividend shield portfolio has a higher beta than the market, which is not what is typical for most dividend growth investors, i bet that 80% of all dividend investor portfolios out there look more like a low beta portfolio with lots of consumer goods stocks. And than the opposite of his conclusion is right.

[Seppia]

My favorite argument for why I like a slight dividend tilt in my asset allocation comes from jacob some time ago here

“You cannot fake cash”

[thef0x]

One bias that this thread has helped me uncover is a "past performance as strategy" bias (a posteriori), contrary to what @Salathor suggests which appears more like a priori logic to me.

Unfortunately, being logical hasn't seemed to pay off -- maybe the a posteriori argument here is that humans are greedy speculating machines and to expect us to act logically when instead we could gamble (emotional logic, I guess) would be to fight humanity in its very essence.

I do find the natural sector weighting of higher dividend equities worrisome because of missed gains in other potential growth sectors, specifically tech (a posteriori argument). Then again, so much of that tech growth was fueled by QE, so hard to say what's real productivity vs monetary policy... certainly we have new, faster, gadgets, healthcare innovation, etc.

Still, I feel like there's more here I'm missing.

[frommi]

https://engineeredportfolio.com/2016/12 ... y-sectors/

This is from 2016, and surely the conclusions today are a little different, but you don't need tech at all in your portfolio to perform in line with the market. And who knows maybe tech underperforms in the future, like it did from 2000->2008.

[jacob]

Dividend investing for FIRE provides a less abstract strategy where you get to spend what you see in a very concrete way. It's very similar to the original YMOYL approach in that way. You don't have to believe in statistical risk analysis, "past returns", or sequence of returns baloney. You don't have to listen to meditations or soothing voices telling you that the market will go up in the long run whenever it goes down 20% because it doesn't matter where it goes. Also you don't have to come up with cute names to put bandaids on what are obvious risks. It's as simple as it gets.

All you have to do is to build and maintain a portfolio of dividend payers that is robust enough not to get cut and solid enough to keep up with inflation. You'll be able to FIRE when payout > expenses. Also, US tax policy is ideally written for this kind of approach although to be fair, the more popular total return strategy is also highly compatible with US tax policy, especially now that all financial companies keep accurate track of cost basis.

Downside: When robustness and inflation tolerance are a requirement, you're generally looking at yields in the 2-3% range. This is on par with very early retirement since those would also be the SWR for what is practically a perpetuity. It's likely oversaving for more traditional retirements where the money only needs to last a few decades.

In conclusion, it's closer to thinking like an actual investor. These days it's more common to think of the market as either speculative (greater fool) gambling or a magic money machine with a greater interests than a savings account on the condition that one accepts all kinds of optimistic beliefs.

[chenda]

I'm wondering what's drawing you specifically to dividend investing vs other potential strategies, if you'd be interested in weighing in.

It's more just personal preference as much as anything. As Jacob notes it's a simple and easy strategy, and it's not hard to find FTSE100 companies which yield 3-4%.

[zbigi]

Will they still be yield 3-4% in 20 years time? Will the stock value decline, so exchanging them for better earners will come at a loss? IMO there's nothing simple and easy about stock picking.

[chenda]

Will they still be yield 3-4% in 20 years time? Will the stock value decline, so exchanging them for better earners will come at a loss? IMO there's nothing simple and easy about stock picking.

I am not advocating set and forget, although many of these companies have decades of positive dividend growth, fwiw.

[jacob]

@zbigi - It's not as simple and easy as buying VTI and chanting "up in the long run" but it's not rocket science either. I think the main danger is self-inflicted. Investors chase higher yields as a short cut for needing less capital for pretty much the same reason that Total Return investors are tempted to come up with intricate withdrawal tricks to justify a higher SWR.

Obviously things can happen in 20 years, but choosing key companies with good balance sheets and good [dividend] track records will ensure that misfires are relatively rare. One does have to pay attention to whether the business model is about to steamrolled. For example, ideas like rural landlines, local pharmacies, mainframes, and tupperware weren't meant to last forever. You don't have to predict what the world will look like in 20 years but you do have to be sufficiently aware/detached to let go of the losers.

I think what makes [dividend investing[ work for some is that it is very hands-on. The mechanics forces honesty. A dividend cut is a dividend cut and you see this directly when your income drops because the dividend was cut. It's a lot easier to fool oneself when math and statistical analysis gets involved. I think that the more direct consequences forces investors to pay more attention to what they are actually buying and what they're owning.

It is a learning process though. I've experienced two crashes in my career: 2009 and 2021. The first time in 2009 I had several cuts because I was indeed chasing yield. In 2021 I had one cut and it quickly recovered. This time because I was a lot more focused on whether a company could cover their dividend than how to get an extra 1% in yield.

[thef0x]

For example, ideas like rural landlines, local pharmacies, mainframes, and tupperware weren't meant to last forever. You don't have to predict what the world will look like in 20 years but you do have to be sufficiently aware/detached to let go of the losers.

Wondering how you manage the tax implications of selling off positions that have gains in price, given you feel it's time to get out of XYZ (tupperware)? <-- I'm assuming your other dividend income / book income / etc is already exceeding your expenses (I think I this read on the forum somewhere); my W2 income puts me in a similar position and, for me, selling for any reason feels bad as such. I also tend not to try to catch the falling knife, so in general I'm in camp never sell.

I'm also not so active that I can tax harvest losses to mitigate these concerns; in general all of my portfolio is roughly up or down.

Question goes for everyone pursuing this strategy.