From Morningstar: 2024-11-19 08:16:26

Investors are divided on dividend investing, with some seeing it as a positive strategy for steady income while others criticize it as a cut into total return. Mixed messages in financial news contribute to confusion about dividends, leading to pitfalls like the dividend fallacy, where investors may overestimate the benefits of dividend payments. Additionally, high dividend yields can sometimes be a warning sign of a potential dividend trap, where declining share prices artificially inflate the yield. Investors are advised to focus on total return rather than dividends alone, as share price declines may signal future challenges or dividend cuts. Selling shares for income can be a safer strategy than relying solely on dividends, providing flexibility and avoiding forced sell-offs.

A dividend-focused investment strategy can help with safe withdrawal rates by providing a consistent income stream without the need for frequent sell decisions. This approach can sidestep the challenges associated with determining safe withdrawal rates over longer retirement periods or high market valuations.

Creating your own dividend by selling shares can provide income flexibility, but some investors may find this approach less appealing due to decision regret and psychological factors. Dividend investors benefit from regular income without the need to sell shares, avoiding potential regret associated with sell decisions.

Long-term performance of dividend stocks versus the broader market shows that dividends as a portion of earnings have shifted over time, with companies paying out a smaller portion of earnings as dividends. Factors such as share repurchases and the rise of mega-cap growth companies not paying dividends have influenced this trend. Data suggests that higher-yielding stocks have outperformed the broad market over certain time periods, emphasizing the importance of considering long-term performance when investing in dividend stocks. In the past 30 years, the broad market has outperformed dividend-focused portfolios due to tech and communication service firms. More top companies are now paying dividends, with yields below 1%. Share repurchases can be more tax-efficient for shareholders compared to dividends due to the reduction in share count, leading to potential share price increase.

Drawbacks of a dividend-focused strategy include solely focusing on yield without considering valuation or future earnings growth. Investors may miss out on sectors with greater potential returns. However, if dividends help achieve financial goals and increase savings, it can be a suitable strategy. It’s important to consider personal behavior and goals when choosing an investment strategy.

Dividend investing may lead to bad investor behavior if individuals only focus on yield. While dividend stocks have historically been a significant component of total return, recent trends have shown a decrease. Ultimately, investors should choose a strategy that aligns with their financial goals and motivates them to save and invest effectively. Dividends are a way for investors to save for future goals, like retirement or education. They provide a tangible income stream that can be matched to expenses, creating positive investor behavior. Creating your own dividend is an option, but it lacks the excitement of receiving regular dividend payments. Understanding the psychology behind dividends can help investors make informed decisions.



Read more at Morningstar: What You’re Getting Wrong About Dividend Investing