Dividends in a Bull Market (photo credit)
Over the first few years of early retirement I noticed a disturbing trend… dividends were increasing at a much too rapid pace!
Between 2012 and 2017, the dividend payout of VTI / VTXAX grew at an annual rate of more than 9%! The growth rate on our portfolio was even higher (14%+) which brought annual dividends from $28,139 in 2013 to $36,760 in 2015. Annual inflation over the same period was only about 1.5%.
While dividend growth investors were most certainly overjoyed, I was busy reducing our dividend income.
Please, corporations of the world… stop paying so many dividends.
Returning Shareholder Value
We own stock with the expectation that, in the long term, we will receive both income and price appreciation as companies innovate and grow. Historically, the total return has exceeded both inflation and the return of other asset classes. This is why our portfolio is primarily equities.
Smaller firms are often cash limited, but as the company and profits grow excess cash is often returned to shareholders. The two most common ways are:
- Pay dividends
- Buy back shares of stock
In terms of book value, dividends and share buybacks are equivalent. One puts cash in your hands today, the other increases the value of the remaining shares which can be sold for a capital gain. In the short term, the market may have different opinions. The Economist does a fair job of summarizing this (up to the point where they call Warren Buffett delusional.)
When it buys its shares or pays a dividend, a firm is transferring cash to its owners. In neither case does this alter the underlying value of the firm, which is determined by its expected cash flows and their riskiness. Instead all that happens is that the financial instruments with a claim on those cash flows are reshuffled: the value of the firm’s equity declines, its cash falls (or debt rises) and investors’ cash holdings rise, all by an identical sum. In both cases, owners’ wealth is also unaffected: those who sell shares in a buy-back end up with more cash and fewer shares; those who do not end up with a bigger slice of a smaller pie.
The text book version is also very nice.
Equivalence notwithstanding, preferences are passionate, which I imagine may make an appearance in the comments. (The Canadian Couch Potato does an excellent job of reviewing the opinions.)
Passion is nice, but so is math. And the math says six of one, half dozen of the other.
Why Reduce Dividend Income?
So if they are equivalent, why reduce dividend income? One word: control. (And maybe a 2nd word: taxes)
Corporations pay dividends on their schedule, not mine. And their schedule may result in a higher tax bill and/or the reduction of income based benefits (e.g. ACA subsidies, tuition assistance, Saver’s credit, other tax credits…)
These are all strong likelihoods for anyone in the accumulation phase with taxable accounts.
For somebody in the withdrawal phase, today’s dividend income also has the potential to increase future taxes; every dollar of unqualified dividends is one less tax-free Roth IRA Conversion dollar, and every dollar of qualified dividend is one less tax-free harvestable capital gain.
Reducing Dividends
To reduce dividend income, I didn’t do anything fancy. As part of normal year end tax management in 2015, I simply sold the last of our remaining individual stocks. (See our asset allocation.)
At the time, this was less than 10% of the total portfolio. However, it was producing more than 10% of total dividend income and 25%+ of unqualified dividends.
Contributions to my solo Roth 401k and to his/her individual Roth IRAs (0 tax in, 0 tax out) slightly reduced the post-tax/taxable ratio of the portfolio. The remaining proceeds were added to our brokerage account holdings of VTI and VXUS. The combination of fewer shares held in taxable accounts and the lower yield of VTI / VXUS reduced total dividend income by ~9%. (When I looked in Dec, this portion of the portfolio had grown by 10.4%, whereas the basket of deplorable stocks I once held had grown 8.3%.)
As additional benefits, I’ve increased diversification (replaced 10 stocks with 9,641) and increased small-cap exposure (replaced BIG companies with small ones.)
What are companies doing?
While I’m asking companies to take it easy with their dividend increases and do more share buybacks, what are they actually doing?
It turns out, they are taking it a little easy with their dividend increases and doing more share buybacks.
The historical average dividend yield since the beginning of time for the S&P500 is ~4.4% (Shiller data) whereas for the past 15 years or so it has been more like 2%. This is also roughly the current yield of VTI.
But post financial crisis, with share buybacks included total “yield” is ~5%. Nice. Keep trending in that direction, please.
Data from random Google search to this pdf.
Final Thoughts
The rapid growth in dividends in recent years was raising potential issues for control of income and taxes. To slow it down a notch, I sold all of our individual stocks and replaced them with index funds. This reduced total dividend income by ~9% and eliminated the source of 25% of nonqualified dividends.
The preference of buybacks vs dividends for corporations does seem to be trending towards buybacks. Thank you corporations of the world!
Do you have a preference for Dividends or Buybacks?
—
See All of Your Accounts in One Place
Track your net worth, asset allocation, and portfolio performance with FREE financial tools from Personal Capital.
Jeremy,
I focus only on investments that pay me to hold them. Historically, dividend growth on US stocks has exceeded inflation in the range of 2%-3% /year. Not bad.
Dividends are also more stable than capital gains, which makes them an ideal source of income for retirees. In fact, over the past 90 years, dividends on S&P 500 have been flat or up in 90% of years.
Dividends are more secure than capital gains, particularly in the short term, which is helpful to retirees living off their portfolios. The average yield is about 4% over the past 90 years. Surprisingly, historical research has “found” that it is safe to withdraw 4%/year from your portfolio in retirement. The real reason for the 4% rule is the power of dependable dividend income.
A portfolio of securities can be worth $1M today, and $500K next year or $1.5M the year after – I have no idea about it. But I am much more certain about the amount and timing of dividend payments I will receive.
As far as the “myths” about dividend investing, the author there set up a few straw man arguments, which he refuted, regardless of whether they were grounded in fact.
As for stock buybacks being the same as dividends – they are not. With dividends you are receiving cash on hand, that you can do anything with. When a dividend policy is set up, it is there and is highly visible. With share buybacks, corporations can cancel them at any time. Usually the timing of buybacks is terrible – corporations buy stock when they are flush with cash and valuations are high, and stop them when they are uncertain about the future and prices are low. Corporations do not take into consideration whether they are overpaying for their stock or not. It is silly to pay $2 for $1 worth of stuff. Case in point – GE’s share buyback which bought shares high, and then sold a bunch of shares during the financial crisis at a loss.
By the way, academic research has shown that investors usually sell investments right before they go up, and buy investments that didn’t do as well as the investments sold. I would be curious to see how the investments you sold in 2015 have done relative to the ones you bought.
As far as taxation, it is a moot point, since a very large portion of stocks are held in retirement accounts. Unfortunately, you do pay a tax on dividends in the accumulation phase of something like 15%.. You can eliminate that tax by placing your diversified custom built portfolio of blue chip securities in a Roth IRA. Direct ownership of securities does not cost anything. If you owned an index fund that charged you 0.10%/year in perpetuity however, this is equivalent to a 5% tax on your dividend income as well. You will be paying that tax for a long time.
Best Regards,
Dividend Growth Investor
DGI,
Jeremy provides an explanation of adjustments he’s making to his particular portfolio for his situation. He’s making the change to lower his overall dividend income and especially his nonqualified DI.
Some of the points in your comment seem cut-and-paste generic and aren’t applicable to GCC’s situation. Taxation is moot because most funds are held in tax-advantaged accounts? Clearly this isn’t the case for GCC as he’s adjusting his TAXABLE portfolio. The fee on VTI is 0.05% (half of what you mention with 0.10%). BTW you can buy ITOT from ishares for 0.03% with no trading cost through Fidelity if VTI is too expensive.
You raise valid points but these points aren’t necessarily relevant to someone like GCC who has a large taxable portfolio and doesn’t need 4% yield.
If I’m living off 2% of my taxable portfolio per year why would I want dividends of 4%, growing at 8% per year? In some situations it might be more advantageous to receive 2% per year, enjoy the benefits of a lower AGI and selectively realize cap gains in certain years of your choosing.
Every once in awhile somebody writes a perfect comment. Thanks Karl!
Karl,
I answered Jeremy’s question at the end:”Do you have a preference for Dividends or Buybacks?”
I didn’t cut and paste anything – except from my brain ;-)
The point is with dividends you get your money back at a relatively more known rate;with capital gains you are at the mercy of the market & earnings multiple compression.
Hi DGI,
Like I said, people are passionate about their preference :) I’m good with both.
I also focus solely on investments that pay me to hold them. That is the definition of asset.
Dividends can (and are) reduced/eliminated. See Bank of America. (Q3’08: $0.64, Q4’09: $0.01 (-98%), Q4’16: $0.075)
re: “I would be curious to see how the investments you sold in 2015 have done relative to the ones you bought.”
I knew somebody would ask, so I included this in the post (I’m up.) But a year is a short time.
I’ve never seen anybody say that taxes are a moot point. I disagree.
For a real world example, see me.
re: an index fund charging a fee in perpetuity
VTI has outperformed its index by a few basis points over the past decade, in part due to income from securities lending. In actuality, the fee has been negative.
It’s all good though. You keep asking corporations to raise their dividends, I’ll keep asking them to increase buybacks, and they’ll do whatever they want (which is probably both.)
Cheers, and thanks for the discussion.
Jeremy
Hi Jeremy,
I am passionate, but you asked me a question so I had to answer ;-) Hopefully one day we can meet and discuss in person over a few drinks.
In reality, I am flexible and hold DGI stocks and index funds in my 401 (k). Actually, I see S&P 500 or VTI as dividend growth stocks as they raise their dividends over time ( I think 7 -8 years in a row as of now).
Individual dividends can and do get cut, but from a portfolio perspective this is actually rare for US stocks ( looking at nominal S&P 500 pmts) – other than the steep cuts in 2008 – 2009, it is pretty smooth sailing actually.
I asked the question on the stocks just for my own reference purposes. I can tell you that anytime I sold anything, it was a bad decision in retrospect. Some academics concur on that. Some data I have gathered also confirms it. But I agree that an year is a short time, perhaps talk to you in 2025?
What I meant for moot point on taxes is that in general most people hold investments in tax deferred account. In taxable accounts – it depends. When I decide to battle the one more year syndrome, the dividend income will be tax-free. Unless of course DW doesn’t continue working or my side hustles become as popular as GCC.
Do you have a link to the source that VTI has negative fee? I see the 0.05% – ITOT is 0.03%. Actually, you can lend securities using Interactive Brokers, and they will split the revenues 50/50. There is risk if the other party defaults and can’t pay. Plus, the dividends you receive won’t be qualified but ordinary income ( while you have lent those shares).
Based on my research, corporate boards in aggregate have poor timing and valuation, assuming they go through with them. A lot of our shareholder money has been wasted. Unfortunately, few are as disciplined as Mr Buffett ;-(
For the sake of discussion however, I focus on companies growing dividends as a sort of a quality filter. Certain types of great companies have in the past earned more, and paid more in dividends. But I do not subscribe to the theory of dividends for the sake of dividends.
I also wanted to say that while I disagree with certain items on this post, I have really enjoyed reading your site, and have learned a lot in the process.
Take care!
DGI
Thanks DGI, I appreciate the follow up. I’m definitely up for drinks if we are ever in the same neighborhood.
re: negative fees. Without digging a lot, look at the performance of Vanguard’s S&P500 index fund vs the index. With 0.02% annual fee, you would expect the fund to have a 10 year+ performance error of at least this amount, but in the most recent 10 years it modestly outperformed the index.
I just have a philosophical problem with dividends. I’m giving companies my money because I believe they can invest it and grow it more effectively than I can. And they’re trying to give it back to me. My money isn’t a hot potato!
You wouldn’t accept it if you gave $1M to a home builder and she gave you $40k back and told you that she wouldn’t be installing any north-facing windows. You’d want her to build exactly what you paid for (invested in)!
You are my new favorite person
I saw a chart from FAMA/French which discussed how companies with lowest rate of reinvestment did better than companies with highest rates of reinvestment.
I think it is important to look at the data, and then form an opinion, than vice versa ;-)
You might want to look at Berkshire Hathaways track record.
I was thinking the same thing. Our approach is to have the dividends we want from VTSAX. If we want to reduce dividends and focus only on growth, we put it in Berkshire Hathaway. No dividends/forced reinvestment and completely tax efficient.
I know you don’t like Roth’s during the accumulation phase. I am confused on what benefit they are providing you in the withdrawal phase. Please explain.
There are pros/cons to pre-tax (Traditional), post-tax (Roth), and taxable. Having funds of each type provides flexibility. The Roth provides the 3rd leg of the stool / diversification.
If dividend and capital gains taxes ever increase (or we choose to live in a US State that taxes dividends), the Roth accounts will still be tax free. The Roth can also provide a source of spending when increasing AGI would have a negative effect, such as 2 years before Jr applies for college financial aid or when optimizing ACA subsidies.
Reducing your tax burden is always a worthwhile exercise! The math and concepts in the article, for me are not arguable. What is a good discussion topic is individual impression, feeling of receiving or not receiving the dividend “check”. Another discussion is looking at control of the funds, but different from the articles perspective, that is, individual not corporate control. Buffett likes to keep the funds because he feels he can manage the cash better. An individual may feel similar that they have different direction for the cash. Arguably, one can sell a few shares instead at an inconvenience in money and time. Perhaps another argument for dividends is stock price is not just a reflection of technicals, there is also emotion. The cash dividend once paid will not be burdened with the daily drama of the DOW.
Taxes aside, dividends can provide flexibility for the investor with the option for additional diversified redeployment.
Thoughts
Selling shares doesn’t need to cost time or money. Vanguard (for example) will send you dollars on your schedule, selling off shares (at no cost) if need be.
I agree with you 100%! I can’t stand the disproportionate amount of emphasis people place on dividends. I hate them for the same reasons as you. They destroy wealth for long term investors who are just going to reinvest them anyway. Firms should pay out 100% of payouts (defined as dividends + share repurchases) in the form of share repurchases. Firms should be indifferent between dividends + share repurchases. Individuals should only prefer share repurchases. The only reason why firms behave this way is a historical artifact of when share repurchases weren’t really legal due to stock price manipulation concerns. This changed in the 80’s, which gave firms the green light to repurchase away. Unfortunately, firms have been slow in fully transitioning to share repurchases.
People do get pretty excited about dividends. I don’t feel as strongly as you do about always preferring buybacks, as there are pros and cons to both. The trend seems to be in the direction of more buybacks though, which I see as a good thing.
Oooh, you’re going to get some blowback over this one! The DGI crowd is fierce!
I don’t like dividends either, but I’m also not a huge fan of buybacks. It seems like a last resort for a company that can’t think of anything better to do with its money. I could go on, but Warren Buffett stated the case much more eloquently than I ever could on page 7 of this year’s Berkshire letter: http://www.berkshirehathaway.com/letters/2016ltr.pdf
I hope you’re loving life wherever you are in the world this year!
And are you planning to go to FinCon again this year? I promise to not go to bed so early if you show up again.
Yeah man, life is good. We’ve just been chillin in Taipei for a few months, going on bike rides and playing in the park.
We won’t be at FinCon this year as we’ll still be in Asia. Maybe 2018!
I guess if a company doesn’t have a better use for their (our) money, they could just pay it out as a dividend :p
Bummer about FinCon. I’ll catch up with you in some part of the world someday. Hopefully the ocean is warm and the beer is cold.
just go to Taipei and hang out with them there. we’re just back from doing exactly that and they know an awesome place for dumplings.
Oh, yeah. You are both spot on RE those pesky dividends.
Basket of deplorable stocks, love it!
As one’s portfolio grows it becomes harder and harder to shield income from tax, especially if you’re not increasing your spending. A nice problem to have.
I’d hoped to pay zero tax and hide out in the 15% bracket but as my dividends keep rising it becomes more difficult. Lower dividends gives me more room to convert money from my TIRA to my ROTH. The sooner I can get the funds into the ROTH the better. My projections show that my ROTH conversions won’t make a dent in my TIRA unless I’m willing to move into the 25% bracket, ouch.
Yeah, if the Traditional accounts get “too big” it can cause some tax problems. I have a post coming on this fun topic.
One crazy idea: if you get married to a person with no earned income, the 15% tax bracket doubles in size :)
I’m a fan of dividends in the withdrawal stage. They provide a reliable source of income in retirement and are tax free up to about 75k for couples, as long as you have qualified dividends. I’m not investing in dividend stocks today because I’m in the accumulation phase and don’t need the additional taxable income. When I do retire I plan on converting a significant portion of my portfolio to dividend stocks paying qualified dividends.
I’m also a fan of dividends in the withdrawal stage. But I’d be OK with fewer of them.
Do you expect the big conversion to come with a significant tax bill?
I don’t think so. I would likely do it in stages as I approach the time of needing income. I will also have a Roth balance that I can convert to dividend stocks and avoid a big tax bill. Good consideration though.
I think a really detailed post about the conversion process plan would be an interesting read, assuming a big chunk of it is in taxable accounts.
I agree. That would be an interesting exercise to see how it would work out with taxable accounts. It’s on my list!
Bravo, Jeremy!
I would be happiest with zero dividends, which is why I bought some shares of BRK-B last year. It’s the only individual stock I own, and it pays no dividend.
I’m taxed at nearly 29% (15% plus 3.8% ACA plus 9.85% state) on qualified dividends / LTCG and about 45% on ordinary, non-qualified dividends. That will surely drop in retirement, but the tax drag from dividends is real.
Down with dividends! For me, anyway. I advise everyone else to do what works for you.
-PoF
Perfect example PoF.
ps: love the new logo
Thanks! Got it done over at Fiverr by a guy in Pakistan. It’s Pakistanimation.
I would pay $5 to work with a company with a clever name like that. I tried Fiverr also and it didn’t work out. I went with a Malaysian firm for the current logo
I paid the $20 for enhanced service, but could have gotten it for five (six, actually with the $1 fee).
The name wasn’t actually that clever, although the guy was from Pakistan. I just borrowed the line from Super Troopers.
I’m with you, having control over when to pay taxes is a huge advantage. I didn’t want any capital gains or dividends while I was working. And even now that I am not working, I prefer to have control over the gains I pay taxes on each year :)
In the accumulation phase it’s a no-brainer: I prefer no dividends due to high state taxes and 3.8% Obamacare tax. But even during retirement, there is the advantage of timing the realization of my capital gains myself, not being forced to take dividends when the company drops them on me. Completely agree with you!
Besides: I am getting a bit worried that the whole yield-chasing movement, not just in the FIRE community but in the finance world in general (so many new high-div ETF!!!) is driving up prices for dividend stocks too far. Maybe it’s not a bad time to go against the dividend bandwagon. :) Or if you don’t want to take a stance: Simply split the market into dividend payers and non-dividend payers and keep the former in tax-deferred accounts and the latter in taxable accounts…
Seems like that’s one of those “nice problems to have” GCC.
I look at from a different slightly different perspective than just dividends and buybacks. Overall, I want my company’s earnings to go into a balance of four areas.
1. Maintenance Capital – Money required to maintain the business. In most cases this should exceed depreciation (because inflation!)
2. Growth Capital – Obviously I want my company to grow, but growth capital must be applied appropriately and at high rates of return (ROIC). Any capital that can’t be invested at rates of return that meet or exceed that of the S&P500 should be returned to shareholders and not wasted.
3. Buybacks – When done at *appropriate prices* (below intrinsic value) these can create shareholder value. Most of the time, buybacks are done at stupid prices at the top of the market.
4. Dividends – Because of #2 and #3, I expect earnings per share and dividends per share to grow at rates of return that exceed inflation.
Ideally, a good investment is one where all four of these areas are nicely balanced, but finding that is relatively rare. The vast majority of S&P500 managers throw money at buybacks that do little for creating shareholder value…all the while printing more shares in the form of option incentive programs to reward management. It’s disgusting behavior that wastes billions.
So do I like dividends? Yeah, but I also like buybacks when they’re done right.
I probably should have just named this blog, “Nice problems to have.”
I’m referring to excess company cash, so 1 and 2 are implied.
Option incentive programs are a completely different topic that apply regardless of preference for dividends or buybacks.
Great article! As someone who’s been trying to “grow” a dividend portfolio, it’s helpful for me to see the other side of the coin. While I get the gist of where you’re coming from, I had to laugh at a one of your comments. :)
You said, “Corporations pay dividends on their schedule, not mine.” Ok, that’s true they do pick the dates, but hey, it’s not like you don’t know how often and when (approximately) they’re going to pay you. I mean, I didn’t wake up this morning to suddenly find out that Coke had dumped $1000 in dividends in my account. Surprise!
Pretty much the whole world knows the next upcoming payout for Coke will be made on April 3rd, for example.
For you, it sounds like less dividends is better, for me, I’m looking for more. Different strokes for different folks, and that’s ok.
Sure, anybody can look at a dividend schedule.
Since I don’t plan to spend the April 3rd, 2017 dividend until April 3, 2033, I would rather pay taxes then instead of every quarter for the next 16 years.
I’d rather take the dividend. I like simple and I don’t understand buybacks much. And I need income, and a dividend seems a clean way to get income.
On the other hand, I am not a “dividend investor” I don’t buy just for the dividend… hey maybe I am not that simple haha
Hm, I haven’t really thought of it that way. I personally like dividends more than share buybacks, but having control over when to pay taxes would be even better.
I wrote something similar on reddit a while back and people didn’t like it. People are passionate about their quarterly dividend checks. I’d much rather they spend that money on buybacks or things like investing in organic growth, M&A, etc. as long as those have good returns and I’ll get the benefit through appreciation.
Yeah, I don’t see myself ever getting into a buybacks vs dividends reddit argument… It’s all fun and games until preferences turn into dogma.
The reason this is flawed logic is that this statement assumes that executives of these companies generally make good decisions on investments back into organic growth or acquisitions. Certainly some do, but in my experience most do not. I sit on the internal investment review committee of a Fortune 500 co presently (still employed) and I have seen countless examples of investment decisions that eventually will have big impacts on Enterprise Value of the company that are influence by many other things than enhancing shareholder value. Desire to get into a new industry, impatience with accumulating cash on the balance sheet, mis-aligned exec comp incentives, individual ego, settling grudges with execs at an acquisition target. The list is long. Warren Buffet WANTS companies in Berkshire Hathaway’s portfolio to pay him dividends so he can make the capital allocation decision instead of them. As a shareholder, you are likely better off making many of those decisions as well. If you don’t like the tax implications, lobby your congressman for a change in tax regs on divvies or re-structure your portfolio, but trusting that execs at the companies for which you are a shareholder will do a better job is a gamble.
Spot on! This is why I take the cash and buy shares of other companies at a lower price.
Down under we have the choice to companies that offer fully tax payed dividends (full franked). This was a policy introduced in Australia in the 80’s.
The idea is that companies have already been taxed on their profits at the company tax rate (30%), and so when those profits are transferred to the company owners (i.e. shareholders) it shouldn’t be taxed again. In the ETF’s that I own that track the Australian ASX200 index, last financial year the distribution comprised of over 70% of these fully franked dividends.
Along with the first AUD $18000 earned in personal income being completely untaxed in Australia, One can earn quite a lot in retirement and pay no tax. In fact if your franking credits exceed your tax liability at the end of the year, the government will actually refund you that money!
Tax is calculated individually regardless of marital status, so you and your partner can each earn that first $18000 tax free. The next ~$19000 on each of your incomes is taxed at 19%, which is still below the company tax rate, so you will still get some of that franking credit back. As a couple you can theoretically earn upto AUD $74000, pay $0 personal tax through the year and get a tax refund from the government of several thousand dollars!
In this situation I would prefer to earn dividends when I retire, as I am not taxed again when I earn them, and if I want I can still just reinvest them at no loss to me except for a small brokerage fee.
I just hope that the tax policy doesn’t change before I retire!
What do you think GCC, interested in becoming an Australian dual citizen and earning some of your money in AUD?
Taxes change incentives, and for Aussies I would prefer divs over capital gains / buybacks. I believe the same applies for Canadians.
Unfortunately, as a US citizen, I would still get taxed on worldwide income. Any non-US dividends would be considered nonqualified. We plan to visit though… it is probably our next destination.
Each senior Australian can receive $93,745 in dividends from Australian companies (100% franked) and pay net tax of 0%; franking credits $40,176.63 exactly offsetting income tax $-37,498.19 plus Medicare levy $-2,678.44; the companies pay 30% tax. To minimise tax considering company tax and individual tax lumped together each senior can receive $20,281.37 in dividends and will receive a tax refund of $8,692.02 plus Seniors & Pensioners Tax Offset (SAPTO) $1,602.00 plus Low Income Tax Offset (LITO) $444.94 and pay income tax $-2,046.94 for a net tax over company and individual of 0%.
“Each senior Australian …” –> Each adult Australian …
Income, wether in the form of dividends or capital gains; all somewhat better than a poke in the eye with a burnt stick. S&P 500 total market capitalization has increased ~$12.0 T while USA Federal debt has increased ~$10.0 T since 2008. Share market derived income and debt seem conjoined. Prepare for the burnt stick?
There is definitely a crash coming. Maybe tomorrow or maybe in a million tomorrows.
Quite. Next question: What insurance is available, how much does insurance cost for what cover and certainty?
Some people use options.
You poked the bear! You poked the bear! Grabs popcorn, settles down on sidelines for a good show.
(I hold one individual stock that yields dividends and it is a teeny % of my portfolio).
Interesting comments so far. We talked about this Jeremy when we met up in Taipei. I’m more in the same camp as Mr. Tako. I think total return is more important overall. I want a company to use profits to grow their companies. If they provide dividends as part of the investor return strategy, great. The thing I don’t want to see is a company keeps paying dividends when they are bleeding in red.
I’m one guy not too passionate regarding dividends or buybacks. Plenty of companies do both. I’m retired and have a dividend portfolio that generates materially more than we can spend, traveling the USA and world since 2011. (We are home free) Once I start drawing SS at 72 and have to start the RMD from retirement accounts I’ll have even more income, likely at a time when I’m spending less. I should have retired earlier than 58. GCC is one of the few sites I can learn something from. Thanks. Dividends and Cap Gains have such a wonderful tax treatment compared to drawing a salary, I’m happy with either.
Wow, thanks Harold. You’ve made my day.
Sounds like you’ve got everything setup perfectly.
In your situation I think this is a good move. You need to lower your income which is still well above what is required to cover your expenses in order to execute your overall legal tax avoidance plan. If just for example $20k of dividends is enough to sustain your lifestyle why would you want to collect 50% more if it means that the rest of your overall financial plan, Roth conversions and the other income based benefits, gets thrown out of whack.
Regarding dividends vs buybacks I much prefer dividends. Companies have a long history of buying shares back when they’re expensive and then shutting down the buybacks when the markets are in panic mode. Not to mention many companies have been taking on debt to be able to fund both dividends and buybacks. That works until it doesn’t. I just can’t wrap my head around some of these capital return policies that corporations are taking because it’s just not sustainable over the long run. I’d much prefer to see the buybacks cut in half and then that cash just kept on the balance sheet for better opportunities whether that’s buybacks or once in a blue moon acquisition opportunities. Alas that isn’t likely to change because the executive compensation plans at many companies focus on share price/EPS growth rather than real growth of the underlying business.
I love seeing these big picture personal finance type posts because every thing is related to one another when it comes to finances. You can do this, but that means you have to less of that or you get more of that…it really helps to put things in perspective and I find myself looking at the small details too often without taking a step back to see everything at once.
Thanks, JC.
The buyback behavior isn’t super crazy when looking at the underlying reasons. It’s always possible to do better though.
The economy just collapsed? Better keep cash on hand in case the recovery is slow or it gets worse. Maybe pay a few less dividends as well…
Use debt to buy back shares? My old employer did this even though they had a lot of cash.
– Interest paid on debt is tax deductible, whereas interest earned on cash is taxable. Taking on debt can reduce taxable income.
– Dividend payout was 3%+ but interest on the new debt was <1%. Free money.
- Had lots of cash overseas with big tax bill if brought home, but can borrow money at home cheaply.
Boost the stock price by goosing EPS? Investors, both of the professional and amateur variety, aren't so naive as to look at only one metric. See the great work of Aswath Damodaran from Stern School of Business / NYU.
I wish I could totally ditch dividends at this point (and take the financial returns as unrealized cap gains). It would let me qualify for thousands of earned income tax credit. If only I knew how my financial life would turn out while I was building my portfolio, I would have structured things a lot differently!
Other than that annoying loss of EITC, I don’t mind the cash flow from dividends that much. Makes for good spending money. Most of our assets are in tax deferred accounts anyway, so the dividends are tax sheltered for the most part.
I’d be OK with some dividends and some buybacks, as long as the trend is towards buybacks. And indeed, it is.
(See another great post from Aswath Damodaran, Stock Buybacks: They are big, they are back and they scare some people!)
Most of our portfolio is in taxable accounts, so I’ve been keeping an eye on the dividend growth. But in tax-deferred accounts, yeah it doesn’t really matter.
I’d have to use a third option, invest in the business. Buybacks seem to always pick up when the stock is the most expensive. I’d rather them invest that money or at least put it aside until the next recession and then buy their own stock at a discount. Also like you dividends I try to minimize due to the tax burden. So honestly I prefer businesses (outside tax exempt accounts where dividend or not largely does not matter) where they are growing enough to invest further in their business. Then again most of my investment is in index funds so it doesn’t show up much in my actions.
Excess cash only exists after investing in the business.
And then there is the question of how much cash to keep on hand. Apple recently reported over $200 billion in cash reserves, which is more than 25% of the total company. It’s a drag on growth, and attracts activists… better to distribute it. But if you distribute it as a special dividend, you stick your investors with a tax bill, so better to buy back shares. imho
I like your portfolio reallocation. I agree with your move of swapping those risky single stocks with mutual funds. Not to mention it solved your dividend problem. Also, the increased small cap exposure risk should be offset by the increase in diversification that you achieved.
Very interesting discussion, but (un)fortunately totally not applicable to us. We are taxed on wealth and have virtually no ways to shelter from taxation (no Roth’s, IRA’s or similar systems). For this reason we have no preference for either dividends or buybacks at the accumulation phase (we actually have them all). However, for the withdrawal phase, we do prefer cash-flow. it’s just easier to manage life around getting income each month and not having to worry about withdrawal strategies for stocks/ETF’s.
Have fun chilling out in Asia (or wherever you may go this year).
Doing exactly the opposite on my taxable accounts. I prefer the relative safety of dividends to Rollercoaster of nav
Love this post. The Dividend crowd is strong and I keep seeing them popping up everywhere that I thought maybe I was missing out. I’m still in the accumulation phase and I prefer stocks that are growing whereas dividend stocks are generally stable companies with not much growth left. I’d prefer the company use the money to keep growing rather than pay a dividend or to buy back stock. I’ve read other bloggers who want to FIRE on dividends, but with yield not all that high and some dividend paying stocks possibly overvalued…not sure that’s the best route to go.
For me, I already feel we pay too much in tax. In the accumulation phase, I definitely don’t need anything adding to my taxable income.
Now, we still end up getting five figures in dividend income from our taxable accounts…but I’d sure like it if that were lower, and I wasn’t giving up so much of that growth right back to Uncle Sam.
I guess the money for our great wall has to come from somewhere though. I’ll do my part.
Man I always feel smarter after reading one of your posts. Thanks for sharing this information. I think my plan, once I reach FI is to keep most of my funds in VTSAX and just live off of 2-3% per year, so I guess I could just set the dividends to pay out instead of reinvest and I’d be good to go. At the end of the day, we all want the same thing. To gain our freedom and live a good life full of great experiences. There is definitely more than one way to reach this goal and its great to have this discussion from time to time.
I tend to agree with you, but for different reasons. I have this crazy, idealistic idea where I would like to see companies just do buybacks until they are privately owned, and eventually give the employees ownership. Once they get to that point they could treat all the workers better since they don’t have to worry about maximizing profits for shareholders. That could work, right?
Didn’t Karl Marx write something similar?
GCC, you are usually an exceptionally great planner with respect to investments and taxes. This post was a little disappointing with a request for fewer dividends. Due to the natural economic cycle a business will have more cash during economic good times and less cash during the bad times. This will lead to buybacks at high prices and issuing more shares at lower prices. If the “best” use of capital the company can come up with is share buybacks, please give me that money as a dividend. I would much rather have that control of my capital. As far as planning, you plan years in advance with the Roth IRA conversions. The individual stocks with too high of dividend payments can always be invested inside the Roth account. And as you mentioned VTI can always be in the taxable with its 2% dividend. It almost sounds like the dividends and stock gains snuck up on you when you were not watching?.
Jeez, dude. I hate to say it, but you sound a bit like my mother here…
3 things:
– our dividend income can more than double before it would be high enough to be taxed. Planning years in advance… yeah, that’s what I’m doing.
– who said anything about issuing shares during a recession? Your strong preference is clouding your objectivity.
– I want my highest growth stuff in the Roths. Dividend stocks are not it.
Hey Jeremy, I completely agree with your post. I wanted to ask about your comment about highest growth things in Roth. What would that entail for you? Small cap value? Emerging markets? Berkshire hathaway stocks? If you could please elaborate I would greatly appreciate it. Thanks so much!
I just have VTI.
It is a general statement… dividend companies are not generally high growth companies.
(Cue indignant comments ;) But also read the stoic wisdom of JL Collins on this topic.)
I have to be honest, companies can’t generally be trusted to do share buybacks. They just don’t know how to time the market.
Another alternative you could have considered is buying Berkshire Hathaway stock with the proceeds. They are like a mutual fund and never plan to pay a dividend, knock on wood.
Nobody knows how to time the market.
I agree, which is probably a good reason for them to pay dividends. Shareholders can decide what to do with the extra cash. They can keep it in the business, but most businesses just then make terrible acquisitions as the cash burns a hole in their pocket. Thanks for your article, it’s excellent.
I see market timing and buybacks as two wholly independent topics.
I prefer dividend. I don’t trust the buybacks. They always buy at the worse time ie. when the company stock is doing very well. They also use the money really badly like buying a small company and ruining it. I just don’t trust the corporations anymore.
Instead of buying back, I prefer them to reinvest.
I see this argument a lot: “I don’t trust the management, so I would rather they give me the $.”
Do you trust them to grow the business? Sure, that is why I own stocks.
Do you trust them to grow the dividend over time? Sure, that is why I focus on dividend growth companies.
Do you trust them to manage a complex system of interconnected businesses, nations, tax laws, and the competitive environment? Sure, that is why I support hiring the best / most experienced executives.
Do you trust them to do share buybacks? Oh, no way! That is crazy! Management is incompetent!
It’s an interesting argument, which makes me wonder why buy stocks in these mistrusted companies at all.
That kind of perfectly summarizes the counterargument I keep seeing in the thread.
As with anything, we don’t see our own biases. It’s possible that some stock investors have crazy strong biases (and this would apply to both dividend and index investors). The only combat to that is to let the math do the talking.
Math is your friend. Thanks DBF!
Perfect response to the risky buyback argument! Look to the logical foundation of what you’re agreeing to by investing, and you see that the lack of trust relating to buybacks is inconsistent with the whole philosophy of investing in a publicly traded corporation!
The post didn’t really convince me of anything (no offense at all, GCC, I’m just a hardcore skeptic of everything at heart!), but the above realization – combined with the thought that the benefits of a lower AGI could be thwarted by substantial dividends – has convinced me that, at the very least, we can accurately state that those pursuing a Lean-FIRE lifestyle are most likely better off with reduced dividends. Problem is, traditional retirees are probably better off with them: They can have a bit more predictability with regard to the withdrawal rate that is safe for them without concern for the value of a portfolio that is, statistically, likely too small for them.
Works for me. I more or less assume nobody is ever convinced of anything (myself included), we just have to discover the idea for ourselves. Maybe I can help with that, maybe I can’t.
I’ve reached a different conclusion for traditional retirees. Building a dividend focused portfolio means trading total return for income, with increased risk (less diversity) and corresponding greater volatility. If the portfolio is too small, the dividend income is also likely to be too small. Thankfully Social Security is there for them.
Yes, but the skillset of rising to the top positions in a corporation is different than the skillset of valuing company stock and knowing whether they are a good value for the shareholder to be repurchased or a bad value.
Also, I see plenty of successful professionals, who are great at their jobs, but they live paycheck to paycheck too. Just because someone is good at one thing, doesn’t mean they are good at everything.
As for math being your friend – my response to that is the acronym: GIGO
In general, CEOs/CFOs/Board don’t know anything about jet engines, artificial intelligence, satellite orbits, DNA synthesis, computer architecture, etc… yet innovation is at an all time high. Maybe they hired the right people.
Hi GCC, I understand how reducing dividends and moving that free cash to Buybacks would be beneficial for you. However I am still uneasy regarding buybacks. Be definition buybacks have an endpoint. At some point all shares will be repurchased and the company will no longer be public. My other issue with buybacks is that I would much rather see companies investing their free cash to create real value, rather than just using their wealth to “manufacture” gains.
Take IBM. In 1999 there were 1.8 billion shares outstanding, the price at the time was around $120 per share. Over the course of the next 17 years they have bought back over 900 million shares, the current price of IBM is only $180 and that is a rebound from $120 just a year ago.
My point is that buybacks, just like dividends, are temporary shots of cash. They have no relation to how well a company is doing and do nothing to support their future revenues or innovation (the real drivers of successful companies). Buybacks can support the price of a stock but they don’t do anything to the fundamentals of the business. Dividends on the other hand are cash that is in your hand. They increase the overall return on the stock you own and then you get to make the decision to either buy more shares of the same stock or use the proceeds to purchase other stocks. To me the latter is preferable given the greater flexibility it offers.
From what I see companies these days are shoveling cash into buybacks because they lack the will to innovate. There is a reason why Amazon doesn’t pay a dividend, because they innovate and are on a constant growth trajectory – which creates real value. If they decided to spend their money on buybacks instead (which they announced they would in 2016) then they are choosing to boost their stock price at the expense of innovation and true value creation / investment in their business.
Given this idea I would much rather see a company issue a dividend or invest in their business before they choose to buyback shares. In my mind share buybacks are simply a company’s last option to create the appearance of value when they run out of actual ideas to create value.
That being said it does make sense, given your situation, to aim to reduce dividends for tax purposes. I also applaud the idea of moving from a basket of stocks to broad ETFs and funds that contain thousands of stocks. This move is advantageous for you because it reduces your dividend income while also increasing your diversification. This is a good thing. However, if I had to own individual stocks I would much rather prefer to own stocks that either pay dividends or innovate rather than spending on buybacks. However, like you I see the tax complications of large amounts of dividends and so therefore choose to have all my high yield stocks in my tax advantaged accounts :)
Excess cash… means cash after investing in the business.
Value stocks (BtM) generally have a higher future expected return. High dividend stocks used to be Value stocks.
I can offset capital gains with tax loss harvesting, but I cannot offset dividend income.
Most of the desire for dividends is behavioral, not economic.
http://www.etf.com/sections/index-investor-corner/swedroe-investors-odd-affection-dividends
I understand the tax benefits in some jurisdictions of buybacks over dividends. One thing I don’t like about buybacks is that they can force people to sell to who need the cash flow (retirees etc), which leads to trading costs and a permanent reduction in the number of shares held.
As to concerns over the Board having the ability to time the market (or tendency to overpay for own stock), I think it this argument is not as hopelessly flawed as GCC seems to think it is: (1) People generally don’t work for companies they think are going down, the Board is likely to be bullish on the future, regardless of reality; and (2) Anyone who has worked in M&A will tell you Boards/management nearly always over-value their own business. It’s human nature to be optimistic on the future, and down play risks.
I also think concerns over manipulation and short-termism are legitimate (e.g the Board choosing to boost short to medium term EPS through buybacks rather than investing for the long term).
There is no difference between receiving a dividend and capturing a gain. In the case of buybacks, each share you have owns a greater percentage of the company. You may have fewer shares, but you own the same percentage of the company. Or you have fewer shares, but same or greater net worth. There is also need to pay transaction costs or even think about the process… Vanguard will send you money on your schedule at no cost / no transaction fees.
You are probably overstating my position. Are boards and executives perfect? No, of course not. Will they do stupid things from time to time? Of course. Is this statistically material to the success of my retirement or growth of the portfolio. No.
The short term eps concern is also overstated. If the company pays a dividend or buys shares, they can’t also invest those funds in long term growth. Passive investors aren’t making moves based on eps. Professional active investors aren’t so incompetent as to make decisions based solely on one metric. People who watch Mad Money may be, but their ignorance is a different problem.
In summary: same same.
We are coming at this from two different angles. You are looking at it from a personal investment point of view (unsurprising as it is the reason for the blog post), I’m looking at it from a broader market perspective.
I agree with the math on the their being no difference in receiving a dividend and capturing a gain through a buyback.
If TechCo utilise an open market buyback instead of paying a dividend, and Old Tony relies on the usual $500 dividend for living expenses, his shares will be worth more after the buy back, but he would need to sell some to meet his living expenses. So, the transaction costs will eat into the gain. Is this correct, or am I missing something? I appreciate this is only really an issue for smaller divestments and people who don’t use index funds (i.e. those with more concentrated portfolios of dividend stocks). Obviously capital gains and income tax affect the equation as well. I suppose the point is buybacks are good for you (and me), but maybe not for others who set up their portfolio before buybacks and index funds were ubiquitous.
My concern with buybacks is that they can be over-used (i.e. too much cash is spent on them). Companies paying out too much for dividends seems less likely. If lots of companies start using the activist investor playbook of buybacks for short-term gains, it could have an effect on the overall performance of the market in the long-term, if it leads to under-investment.
Topical post, good work. No doubt you got a nice bump in traffic!
Have considered swap-based ETF’s? Not sure what is available to Americans, but in Canada Horizons offer many of these, which effectively transform cash distributions into capital gains. For instance, HXT (http://www.horizonsetfs.com/etf/HXT) tracks the TSX 60, currently has an MER of 0.03% and does not distribute cash to holders. The flip side is that the counter party to the swap can fail to honor the contract i.e. there is added risk, although given the structure of the fund, derivative exposure is limited to 10% of the fund’s assets.
Why do you have high unqualified dividends?
We don’t, but unqualified dividends reduce tax-free Roth IRA conversion space dollar for dollar. Zero is the ideal amount to have.
I’ve kept this blog posting in mind for a bit. I really wish there was a knob you could turn, at any time, to select whether you wanted the dividends or for the company to keep them and invest (how this would work, I have no idea, since different shareholders would elect different things and then how would the stock be valued?). But it would be awesome to take the dividends if/when you need them, else let the shares appreciate. For now, I’m reinvesting dividends, which I thought would be useful as an alternate income stream if I were to lose my job, but if that doesn’t happen, i don’t really want them (or to pay taxes on them) and would rather short circuit their reinvestment w/o the current tax drag. Oh well, so much for wishful thinking – I can totally see your point.
Had USA dividend imputation, like Australia, then your company could receive the dividends and tax credits as income and distribute or not what ever amount of profit was seen fit to whom or what ever as dividends with attached tax credits and not be double, or triple, taxed.
The knob you do have is your 401k/IRA/tax-deferred accounts. It’s best to hold investments that throw off income there, if possible.
I have pretax and post tax investments (hey, when you are maxing your savings, you can save more than 18k/year). Pretax is dominated with income-y stuff (bonds and and REITs, unqual’ed divs), since its yield is taxed at ordinary income rates. Growth-y stuff with qual’ed divs are in post tax accounts, so as to take advantage of preferential long term cap gains, but yet there is where I get div tax drag. At one point, I was wishing for more and more divs, but at this point, like I said, I don’t really need the divs except for if the s-hits-the-fan, then they are my backup income stream. Until then, well I just reinvest. I don’t like to do the DRIP kind of thing with dividends because it produces really long chains of small lots, so I just aggregate them and throw them into one larger purchase of what I’m working on rebalancing into. I keep some stock funds in tax advantaged account so I can also do tax free rebalancing in there, if I want to.
Many of us replying are in the Nice Problem to Have category. If all GoCurryCracker readers follow your advice and live below their means they will soon no longer worry about the current max tax bracket of $77,400. Their dividend growth and spending habits will bump them to the $165,000 bracket. Once the RMD’s kick in and one starts receiving SS benefits at 70 you can easily be bumped into the $315,000 bracket. In retirement mode the dividends allow me to be on auto pilot.
I’m not a tax expert but I do my own taxes. With no earned income, no itemizing our actual federal taxes paid is only about 9% of gross. The biggest mistake I made planning for retirement was not realizing my greatly reduced taxes and tax rate with only dividend income. We are SD residents so no state taxes.
When Roth’s came into vogue, my income exceeded the max and I never did any conversions.
Now touring Chile.
Great posts, thanks.
Definitely Dividends. It’s cash and it won’t go down in the case of a market downturn
Dividends can, have, and do go down
do go down: taking the share price with it.
I meant the cash you get and withdraw from the account (the ones you don’t reinvest).
If your logic was absolute, then while you use to work you’d prefer to receive stocks from your company than a Paycheck, right?
Who would want that? I cannot pay my bills with stocks without selling them for the market price. While dividend are actually cash you can spend and pay bills now just like your paycheck!
I’m not a financial guy but it doesn;t make much sense not liking dividends. John Rockefeller used to say that as well and I agree
A dollar is a dollar.
If it’s not on my pocket it isnt
I understand your argument, especially for your situation where every increased dividend has tax implications and throws a grain of sand in your finely tuned early retirement machine. I personally, would always prefer a dividend increase over buyback since it would increase my recurring annual revenue stream. Buybacks are a short-term boost. With that being said, dividends are not always safe and there are plenty of companies that can recklessly increase their dividend out of the safety zone and lead to a future dividend cut. Am I allowed to throw out a generic it depends on your situation, the company’s financial situation, debt levels, and their management team?
Bert
How about we replace every dividend with a buyback. Then they aren’t a short-term boost and you can add them to your recurring annual revenue stream?
There’s a whole DGI investment strategy that seeks exactly what you’re avoiding. I know that your main thing is to avoid paying taxes but I’ll tell you what…I definitely love to see my dividends dropping into my Brokerage acct!
People love all kinds of things. Dividends, fast cars, crystal meth…
@GCC – one of the funniest answers I think I’ve ever seen. ha ha ha!!
Definitely don’t agree. As a DGI investor the only think I see is dividend growth.
I won’t feel a bear market because I don’t really think about the cap appreciation however you will feel the heat pretty badly and many will. You probably won’t care as you’re rich already but you should think about people who follow your advice, panic and sell at the bottom !
I’m rich already… hmmm, how did that happen? ;)
No need to agree or disagree. It’s math.
Very interesting to see so many “oh I hate dividends so much … i give my money to companies for growth and give me my money back”.
Most of these folks have never been close to a management team that often destroys value through horrible acquisitions and share purchases. I have worked in corporate finance for a long time and the shareholder value destruction is mind boggling because the profits have to be “re-invested”. Billions poured into terrible acquisitions only to take write downs a few years down the line. And then the repurchases are used to manipulate EPS targets so management could use shareholder wealth to reward themselves for hitting the target. Repurchases are also a great tool to hide the dilution of your shares. They are buying back all the additional shares they issued to reward themselves.
Management teams get a free pass now in what seems a perineal bull market. But if a day of reckoning comes and a decade of disappointing growth. People will be singing a very different tune.
Lot of these same folks were very puckered up with the March drop.
Think of owning stocks and dividends as something similar to owning property and collecting rent along with appreciation. It’s a good thing. Reinvesting for the sake of reinvesting is a terrible idea, which is what happens. Very rarely management teams will let the cash build up and be patient for attractive opportunities.
Take the cash homie before a terrible management team destroys it. The S&P500 was made up of very different companies 20 yrs ago vs. today. There is a lot of shareholder value destruction that happens along the way
You can always tell when people only read the title.
Have you even seen a chart of the SP500 over the past 20 years?
“perineal bull market” :-o I’d stay far away from this! Taint right!
Too funny!