Should You Depend on Dividend Stocks?
There’s a popular perception that “dividend stocks,” stocks known for paying out consistent dividends, can deliver decent returns, while also creating a dependable income stream for spending in retirement or elsewhere. But is loading up on dividend stocks really such a good idea? Building a concentrated position in dividend stocks may be appealing at first glance, but a closer look reveals cracks in the foundation. First, let’s look at how dividend stocks deliver their returns. Next, let’s see why we prefer the total return approach of a more globally diversified investment portfolio, even when you’re spending down your investments in retirement.
More Dividends Equals Less Capital
One of the greatest misperceptions about stock dividends is that they represent “free” or “extra” money, beyond the capital value of the shares you hold. This free-dividend fallacy leads many investors to think of stocks as their “cake,” and dividends as an extra layer of frosting. However, this view is not true.
As University of Chicago’s Samuel Hartzmark explains:
“[I]f you have a stock that is worth $10 and it pays a dollar worth of dividend, the price goes to $9, and you’ve got a dollar worth of dividend. So, unlike the bond where, if it paid a certain coupon payment, you end up with more money, when you receive a dividend, you have the exact same amount of money, just labeled slightly differently.”
Think of it like this—dividends are a bite out of your cake. You might not notice a specific dividend-driven price drop, since market pricing mechanisms are always instantaneously adjusting share prices based on myriad factors. But it’s there. Post-dividend, your stock—your slice of a company—is worth a tiny bit less.