We all know the stock advice. Buy stocks that pay dividends. After all, it’s Warren Buffet’s advice, right? And it feels like a good way to earn passive income.
Well, this guy MrMoneySmart has a different opinion:
Dividends Are Robbing Your Portfolio Here’s How /THREAD/
One of the biggest myths on Money Twitter is that dividends are free money “Buy dividend stocks and earn money while you sleep” are all the “gurus” shouting to young beginner investors But what if I told you that those dividends are actually costing you money while you sleep?
First, a dividend is a part of the earnings that a company returns to the shareholders It usually happens every quarter, with some companies (mostly REITs) paying them monthly But while it’s nice to see money coming to your account, you wouldn’t be happy if you did the math
Let’s have two young investors, Mr. DRIP and Mr. Compounder Mr. DRIP invests in 1 share of the company “Shower Inc.” “Shower Inc.” pays a 2% yearly dividend, which Mr. DRIP automatically reinvests by buying more shares at the current price
Mr. Compounder invests in 1 share of the company “Grower Inc.” “Grower Inc.” does not pay a dividend and reinvests all the earnings back in the company
Both companies are stalwarts in their industry and • Are growing at 8% annually • Have a P/E of 15 • Have a stock price of $100 In general, the stock price follows the growth of the business
In Year 1: Mr. Drip received a $2 dividend and has to pay taxes Dividend taxes range from 10% to 37% depending on your tax bracket Let’s assume a 20% tax, which leaves him with $1.6
He reinvests the $1.6 by buying 0.016 shares in “Shower Inc.” at $100/share He now has 1.016 shares worth $101.6
Mr. Compounder does not receive dividends “Grower Inc.” reinvested the $2 back in the company Mr. Compounder now owns 1 share worth $102
Next Year both companies grew by 8% “Shower Inc.” shares are worth now $108 Mr. DRIP receives another 2% dividend of $2.16 He pays $0.43 in taxes and reinvests the rest He buys 0.016 additional shares at $108/share He now has 1.032 shares worth $111.46
“Grower Inc.” shares are now worth $110.16, after an 8% growth The 2% dividend of $2.2/share is not distributed to shareholders and is reinvested in the company The stock is now worth $112.36 Mr. Compounder now has 1 share worth $112.36
Do you see where this going? Mr. Compounder has still 1 share Mr. DRIP got 0.032 extra shares “for free” But Mr. Compounder has $112.36, while Mr. DRIP has $111.46
If the same continues for 40 years the difference is staggering Mr. DRIP has 1.64 shares of “Shower Inc.” at $2011.53 price/share In total, his shares are worth $3298.91 He got 0.64 shares, more than half a share, “for free”
Mr. Compounder has still 1 share after 40 years That 1 share is now worth $4441.54 His equity is now worth 35% more compared to Mr. DRIP
After 40 years, “Grower Inc.” decides to start paying dividends of 2% per year as well Mr. DRIP and Mr. Compounder both decide to retire Mr. DRIP receives a $65.98 yearly dividend Mr. Compounder receives an $88.83 yearly dividend
How is it possible that Mr. DRIP has more shares but his portfolio has lower equity and receives lower dividends? The answer? Share dilution Every time a company pays a dividend its shares decrease in value
The dilution and the income taxes on the dividend cost Mr. DRIP 1/3 of his equity And now that he has retired and wants to use that dividend income to live he gets 30% less compared to Mr. Compounder who was not a “dividend investor”
Want me to add some salt to your dividend wounds? Do you know all those “dividend kings” and “dividend aristocrats” that they tell you to invest in to get a “secured income”? After all, these are blue-chip companies that have been paying dividends for decades Well, not so fast
The reason? Survivorship bias The current list does not include all the companies that went out of business and vanished Let’s say you jumped into a time machine back to 1990 and tried to invest in all the dividend “aristocrats” and “kings”
You would have some trouble getting your dividends today Why? 24 of the 49 dividend “aristocrats” of that time are no longer trading as the same company
That’s right. 50% of those solid and safe dividend companies have been acquired or merged at much lower valuations, or even vanished Being a dividend “king” or “aristocrat” does not guarantee staying one 30-40 years from now That’s when you need these cashflows to retire
Especially in this day and age of rapid innovation, companies that remain stagnant are doomed to become extinct So if you are a beginner investor in your 20s, do you still want to be a “dividend investor”? /END/
So, did that myth get busted or what? To be honest, what convinced me was not the math, but the last bit about survivor bias. It makes total sense, and you can’t predict the future. The safe bets of the past have nothing to do with what works today. Remember Enron? TWA?
Make up your own mind, but if you want to buy stocks here’s what apps we recommend:
- Buy Crypto, Fractional Stock Shares and Fractional Gold With Revolut
- Degiro Stocks App
- Global Stocks With Programmable Commands at IBKR
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