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Dividends Are MISUNDERSTOOD. Here’s Why

There is no shortage of opinions on the topic of dividends. You can even find individual creators on both sides of the same fight.

With the increasing likelihood of recession on the horizon, your investing choices are more important than ever.

Inthis article, we’re going to look at the opposing dividend opinions, and there are a lot out there.

The question is whether or not dividends are truly good or bad in today’s market environment. Where do you sit on the dividend spectrum?

Doubt #1 — Dividends Are Not MAGIC

The number one point that the dividend doubters love to throw out is: “There’s nothing magical about dividends”, and “Dividends aren’t free money” because “the stock price drops by the dividend amount”.

And that last part is true. The stock price does drop by the amount paid. But there is some magic, and it’s hiding in the math.

So, what’s the difference? Who cares if the company pays the dividend or not if your total money is the same?

Well, in a vacuum, this would be true. But in reality, the stock price is not easy to validate like the dividend is. The company pays you a dividend based on its profits and you receive exactly that, a quantifiable amount of money.

But who decides what the stock price is? The market decides. The market is made of individuals that do not always behave rationally.

During an economic recession, the market is strongly affected by fear. When investors are fearful, stocks are priced lower than they should be. And it is subjective because future growth is a huge factor and nobody can see the future.

The company might be a cool, tall glass of water, in reality. But, investors see something else.

If you invest in a company that does not pay a dividend, then you are just along for the ride during a recession. Even though the company’s profits are unaffected, you must wait until the market is no longer overcome by fear and the price of your shares returns to a fair price.

Investing in Growth Companies that Do NOT Pay a Dividend during a Recession

But if the company pays a dividend that is based on profit, then your percentage gain will be greater when the stock price is pushed lower.

Investing in Value Companies that Pay a Dividend during a Recession

Doubt #2 — Dividends Are Not FLEXIBLE

The second point that dividend doubters love to throw out there is a lack of flexibility.

Investing in dividend stocks means that your spending habits will be controlled by a company’s dividend policy. Instead, you can sell shares whenever you want cash and it’s the exact same thing as a company paying out a dividend.

Well, once again, that first part is technically true. You can sell some of your shares when you need cash, but it’s not exactly the same.

When a company pays out a 1% dividend, the share price drops by 1%.

If a company does not pay a dividend, you could sell 1% of your shares.

It is true in a vacuum, you would end up with the same amount of money in your portfolio in both cases.

Dividend VS Non-Dividend Stocks in Normal Market

That being said, let’s put ourselves in the shoes of a newly retired guy. Guy has invested all of his money in companies that do not pay a dividend. Even if these are all great companies with robust profits, the whole stock market lost value during the Great Recession in 2007.

All things being equal, if Guy instead invested in dividend companies with robust profits, the share price may drop but the dividends would continue. You would still have access to a portion of the company’s profits without being forced to sell your shares at the worst time.

Dividend VS Non-Dividend Stocks Before and After Stock Market Crash

My point here is that one strategy is not always more flexible than the other. They both have their strengths and weaknesses.

Of course, this dynamic won’t play out as clean in real life. Some dividend companies will inevitably suspend or reduce their dividend, which would affect your profits.

One path that many investors take is to invest in a dividend fund or ETF, like the Dividend Aristocrats Fund. Investing in a fund gives you diversity without having to research a bunch of individual companies to invest in.

The Dividend Aristocrats even tend to outperform the greater S&P 500, which brings me to my next point.

Doubt #3 — Dividends Lose to GROWTH

The third point that dividend doubters will hit you with is that growth companies will outperform dividend companies over the long term.

While it does sound sort of intuitive that a growth company would give you a greater return, the historical data might surprise you.

Growth VS Value Stocks by Tokenist

Growth companies are expensive compared to their current profits because people believe there will be growth in the future. Growth companies typically do not pay a dividend because they are using all of their extra cash to grow.

Value companies, on the other hand, are cheap compared to their current profitability. Value companies are typically larger, stable, with less growth potential, and commonly pay a dividend.

Over the last decade, we have seen growth outperform value. But it is important to remember that the battle between growth and value has been going on for a long time, and both sides have had their time in the sun.

Value VS Growth Stocks by Bloomberg

This chart by Bloomberg shows the previous decade has been a growth-dominated period, but the decade before that tells a different story. Furthermore, the reversals in performance tend to coincide with inflection points of the economic cycle, which we appear to be approaching.

Always remember that past performance does not guarantee future returns. Do not let growth investing fanatics convince you that investing has been solved, and growth will absolutely get you more total return in the long run. Whether growth or value performs better is cyclical and depends on the economic cycle.

Investing in dividend companies gives you many unique benefits. A portion of your returns are insulated from extreme market downturns created by fear. This results in superior returns during a market crash.

This feature is felt most by people who depend on their portfolios to fund their lifestyle. You do not want to be forced to sell shares at the bottom of the market. Receiving a dependable dividend allows you to afford your lifestyle without selling as many shares.

Now that you agree that dividend-paying companies belong in your portfolio, you need to know how to find them. Check out this video where I go over my 3 favorite dividend companies in this market. I go over all the tools and strategies that I use when I’m evaluating strong dividend-paying companies.

Until next time.

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