August 2024
Dividends and the Total Return Equation
I read an article this month titled: The Dividends Don’t Matter In Retirement, Either on Seeking Alpha. The author went into a long list of why dividends are irrelevant.
Whatever investing path you choose, as long as your portfolio grows over time, you’re doing the right thing.
There are a lot of people who try to discredit dividends, even those that have a portfolio made up of mostly dividend-paying companies. They claim that dividends don’t matter during the accumulation stage but even go as far as to say they don’t matter in retirement either.
This particular article has a summary that reads:
“Dividends don't matter in the accumulation stage, focus on total return for greater retirement income.
Dividends are a removal of value, not a creator of value, and carry equal risk as share sales.
In retirement, total return and risk level are crucial for portfolio success, not the presence of dividends.
The dividends don't matter in retirement, either.”
Some people are unable to see the beauty of dividends. “Math is math” as the author points out and total return matters. I don’t think any of us will argue with the fact that total return matters because that’s a no-brainer, but let’s not forget that dividends make up a lot of returns over time. So, yes, math is math and we have beautiful dividends in that total return equation.
Here’s a chart showing the power of reinvested dividends over time.
Given that dividends have contributed a lot to the return over time, it means that even during the accumulation stage dividends matter. They provide you with money that can be reinvested allowing your portfolio to grow, not to mention the fact that you are receiving a return on your investment right away rather than having to wait years if not longer to realize a capital gain.
Second, as I mentioned in last month’s post, growing dividends and a growing share price usually go hand-in-hand. As the dividend grows with annual increases, we have eager investors who want to own the company which drives up the share price. That’s good at any point of the investing game, including during the accumulation stage. Yet I continually hear the argument that a company’s dividend policy has no bearing on returns. Well, let’s take a look:
This graph shows how the dividend policy of a company CAN impact an investor’s return. Look at the dividend growers and initiators and compare it to the return of the others, particularly the non-payers.
Total Return = Dividends + Share Price Growth
So, yes, dividends do matter.
Another argument I hear is that dividends are a removal of value. Yes, a dividend is a removal of value (on paper) but often goes completely unnoticed when it applies to the share price over time. If a company can continually increase its dividend, it shows that the company is earning enough cash to return some of it to its shareholders and, because of this relationship, the share price grows.
It takes years of investing to create a retirement portfolio and total return is important to any investor, but to ignore the power of dividends in the building of a portfolio is a mistake.
Furthermore, earning a retirement income from dividends vs selling shares for income are two very different things. However, many still argue that they are the same. Sure, you can sell shares worth $30,000 or earn $30,000 in dividend income and it’s still $30,000 in your pocket, but the impact on your portfolio can be very different.
In one, your total investment is being reduced because you are selling shares and cashing out. In this case, the only way your portfolio will make up that deficit is if the share price of the other companies increases by that value over the next year. You are betting on the market to make up that difference and, to me, that’s gambling and risky.
If you are using dividend income to fund your retirement, your portfolio stays intact and you are spending the income generated from the dividends received. It’s similar to the above example except, here, you don’t need to hope for Mr. Market. Your portfolio’s share count has not decreased at all.
A quote from the Seeking Alpha article states “If you live off of the dividends, you are simply letting the dividends decide your spend rate, your tax efficiency and it becomes your financial and cash flow plan. It becomes part of your estate plan.”
True. But if you sell shares, aren’t you simply letting the price of your shares dictate your spend rate? No one wants to sell shares when the market is down, but if that’s your only means of retirement income, you can become squeezed during a depression in the market. (Think of selling shares in 2008)
The author goes on to state, “Obviously, the dividend knows nothing about financial planning, tax efficiency, the appropriate spend rate, estate planning, or appropriate risk level.
Neither do capital gains. Furthermore, if you’ve built your portfolio properly and know what your spending rate will be in retirement, your dividends will likely outpace your plan.
Finally, he states: Living off dividends “is simply not a good idea in my view.” Which I disagree with completely. I think it’s the optimal idea for retirement income.
My parents’ portfolio grew in retirement. It’s still growing to this day and neither of my parents missed out on living at any point in time. I can tell you one thing about their portfolio - they never bought a company that didn’t pay a dividend.
Does it really matter if people can’t fully appreciate the importance of dividends? No, it does not. I’ve witnessed how they can be instrumental in building wealth and it’s why I encourage my 20-something kids to follow this path too.
It’s hard to pick the winning companies out of thousands for harvesting capital gains later on down the road, so instead, I don’t worry about price appreciation because I know it will come over time with that rising dividend. Until then, I keep watching my income rise year-over-year by doing nothing at all.
Our Dividend Income for July
Speaking of rising income, our July income is up over 10% from last year’s numbers.