3 Reasons Why Dividend Stocks Aren’t Always The Best - InvestingChannel

3 Reasons Why Dividend Stocks Aren’t Always The Best

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3 Reasons Why Dividend Stocks Aren’t Always The Best

Like ETFs, dividend stocks matter in retirement planning. However, they don’t come without potential caveats. 

In response to one of our recent installments on dividend stocks, a Juice subscriber named Kris said:

No matter what, isn’t it better to have a dividend then to not have one. I always thought of it as bonus cash. I usually reinvest my dividends. I tend to like a company better if it offers dividends – I feel like they are rewarding me for investing in their company. I guess I just don’t understand what the downside to dividend payments is. And I agree, you should not think that you can retire on dividend payments alone.

Great thoughts. If you’d like to comment on today’s or any other Juice, please use the feedback link at the bottom of this page. 

Before we address Kris by listing three ways dividend stocks can be less than ideal, here are links to our most recent articles on the subject —

Dividend Stocks: Key Basics You Need To Know

Dividend Stocks In Retirement: The Biggest Lie?

Dividends Don’t Offset A Weak Stock Price

As with anything in life — particularly investing — absolutes tend to not make much sense. There are some investors who literally will not buy a stock unless it pays a dividend. 

Sometimes this works out. 

For example, you would have been better off with Microsoft (MSFT), the second most searched dividend stock in Trackstar, our proprietary sentiment indicator, than with Amazon.com (AMZN), which doesn’t pay a dividend over the last five years. 

However, dividend investors often get caught in finding strong and stable dividends, typically measured by how many years in a row a company has not only paid, but increased its dividend payment. The cream of the crop are the dividend aristocrats with increase streaks of 25 consecutive years or more.

Take General Mills (GIS), the fifth most searched dividend payer right now in Trackstar. Over the last five years, GIS has returned roughly 37%, before you factor in the dividend. Not too shabby. Right now, GIS yields a beefy 3.7% or so. Why? Because the stock’s down about 15% over the last year. (We’ll get to that dynamic in a minute). 

Back to AMZN. It’s up more than 100% over the last five years. Even with dividend reinvestment factored in, GIS doesn’t come close. Just one example of many if we had all day. 

Dividend Stocks Can Be Yield Traps

Dividend yield shows us how much a company pays in dividends relative to its share price.

Because yield is a function of stock price, the lower the stock price, the higher the yield. 

A yield trap is a stock with a low price and high yield for an unappealing reason. As in the company is in trouble, which means the dividend payment could be in jeopardy. 

So, using GIS as an example, that 3.7% yield is high, thanks largely to the stock price underperforming in recent months. If the stock goes up, the yield will come down (without accounting for changes in the dividend payment). 

Dividend Stocks Likely Won’t Fund Your Lifestyle

A few things bear repeating from the dividend stocks in retirement Juice. And they tie together with the first two potential issues with dividend stocks. 

First, to yield meaningful consistent income in most dividend stocks, you’ll need a relatively huge position. We’re talking six figures. To spread that much money across dividend stocks with high enough yields, yet solid stock prices and balance sheets that can support the dividend over the long term isn’t easy. And you don’t want to keep it in one or two stocks because if something happens there, you could be screwed. 

Second, you can generate income in other ways. Heck, if you have $500,000, you could look at anything from CDs to high-yield savings accounts to money market funds over the last couple of years to generate a relatively easy, if not outright safe 5% rate of return. Dividend stocks have been out of favor recently for this very reason. 

Plus, if you’re well-positioned with your six-figure nest egg, you could strategically write covered calls against some of your stocks. In either case — unless you’re writing covered calls or collecting dividend income in a tax-deferred account — you could be paying taxes, if you earn above a certain income threshold. Which is another point to consider. 

We’ll do a Juice in the near future on how taxes work in these situations, but if you’re looking to fund life via dividend income, don’t forget to account for taxes, where applicable. Too many people run this math without doing so. 


The Bottom Line: The Juice loves dividends almost as much as we love ETFs. But we don’t see either through rose-colored glasses. There’s nuance, even in these two very popular investment approaches. 

Ideally, you diversify not only your positions, but your approaches. Owning a solid broad market ETF or three alongside a nice basket of strong dividend payers (maybe via an ETF) and high-flying growth stocks, particularly in tech, can work as a comprehensive plan for many investors.

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