Because The Problems With Dividend Investing Can’t Be Ignored
I’m here today to highlight the reasons why you should not buy dividend stocks. Can you believe it?
I won’t buy and hold a stock that doesn’t pay a dividend. So, why in the world would I be publishing an article like this?
Mainly because I like to examine the other point of view. For any important insights, it can provide.
Let’s get started…
10 Reasons Why You Should NOT Buy Dividend Stocks
My top reasons why an investor should not buy dividend stocks include…
- You need growth rather than income
- Other income investments may be better
- There is a risk to holding individual stocks
- Believing dividend stocks have no-risk
- Chasing high dividend yields is a bad idea
- Because dividends can be reduced at any time
- Rising interest rates pose a threat
- Portfolio diversification can be limited
- Loss of focus on total investment returns
- Dividend income is tax-inefficient
Next, I would like to go through each of these points one at a time…
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
1. You Need Growth Rather Than Income
First, the experts suggest you should invest for growth versus dividends. And there are many good reasons and situations for doing so.
Growth is especially important for younger investors with long time horizons. And higher tolerance for investment risk.
In these cases, growth stocks tend to be the best choice. For better returns on investment.
But successful growth investors can make a good case. By pointing to the long-term performance of stocks of high-growth companies such as Tesla, Facebook, or Amazon. To cite just a few examples.
Their investment returns are tough to match. Even by the best stocks that pay dividends.
Pro tip: Build a well-rounded stock portfolio. By using recommendations delivered to your inbox every month from the Motley Fool Stock Advisor.
Okay. We are just getting rolling.
So, here’s another reason to avoid focusing on dividend stocks…
2. Other Income Investments May Be Better
Many investors, myself included, want their investments to produce income. However, other income-producing assets may be a better choice for some.
Versus even the highest-quality dividend stocks.
Let’s consider a highly risk-averse investor. Someone who can not tolerate a loss on their original investment.
For him or her, perhaps certificates of deposit, money market funds, or short-term investment-grade bonds are better alternatives.
Next up, another point why dividend stocks aren’t worth it…
3. There Is A Risk To Holding Individual Stocks
It takes at least 20-30 dividend-paying blue-chip stocks to build a diversified portfolio.
Sometimes it takes even more. To minimize the investment risk that comes with holding stocks of single companies.
Furthermore, not everyone wants to spend their time identifying, analyzing, selecting, and buying individual stocks that pay dividends. Let alone monitor and manage an entire dividend stock portfolio.
Of course, this risk can be mitigated by investing in highly diversified dividend index funds. Since there are many good mutual funds and exchange-traded funds (ETFs) from which to choose.
Speaking of investment risk, I have another one of the biggest myths about dividend investing for you…
4. Believing Dividend Stocks Have No-Risk
There was a time when dividend stocks were considered safe, boring investments. Held by only the most stodgy and conservative investors.
You have probably heard the cliché that dividend stocks are for your grandparents.
Because grandpa just wants to sit back in retirement and collect dividends. And his social security check. In theory, never worried about losing money on his investments.
Well, I’m sorry to tell ya’, Grandpa…
That’s just not true. It’s one of the biggest myths about dividend investing.
Because you can and will lose money on dividend stocks. Especially if you aren’t disciplined. Or, do not know what you are doing.
Even expert dividend stock investors sometimes suffer from poor results.
We are half way done. But let’s keep rolling.
Since I have another really good reason you shouldn’t be a dividend investor…
5. Chasing High Dividend Yields Is A Bad Idea
Because for anyone tempted to chase high dividend yields. Then dividend stocks are not a good idea.
Yes, it’s nice to earn that extra dividend income. Produced by stocks that yield 6%, 7%, 8%, or even more.
On the other hand, there is a reason a stock’s dividend yield is so high.
Best case, it indicates a stable company with no growth potential and a risky dividend payout ratio. In the worst case, it means the dividend is not sustainable in the future. Leading to a dividend reduction.
As a result, buying stocks with high dividend yields is often one of the mistakes dividend investors make.
Bringing me to my next reason to avoid dividend-paying stocks…
6. Because Dividends Can Be Reduced At Any Time
It is important to know that companies are not required to pay a dividend. And even if they do so. The company management has the complete right to reduce, suspend, or eliminate the dividend at any time.
What’s worse, when this happens. The stock price typically falls by a significant amount.
Thus, the dividend investor who holds a stock where the dividend is reduced. Experiences both a decrease in their future income stream. And a big loss of capital within their portfolio.
Next, there is another problem with dividend stocks and dividend investing…
7. Rising Interest Rates Pose A Threat
When interest rates rise, the value of dividend stocks typically falls. Especially those stocks with extra high dividend yields.
It is because higher interest rates create competition for dividend stocks. Since it means investors can earn more income from other income-producing investments.
Thus, creating more competition from alternative portfolio holdings. Reducing the demand for dividend stocks.
And if I remember my college economics correctly. Reduced demand exerts downward pressure on prices. Specifically, per-share stock prices in this case.
So, as you consider the pros and cons of earning dividends. Don’t forget about the negative impact that higher interest rates can have.
Next, I have another good reason not to buy dividend stocks…
8. Portfolio Diversification Can Be Limited
Dividend stocks are clustered in certain industries and stock market sectors. Mainly in industries that produce steady cash flows. But have limited growth prospects.
Electric utilities, consumer staples, food, beverage, and real estate investment trusts are some good examples.
Sector concentration makes it more difficult to achieve adequate diversification. And ensure the stocks held, do not all reside in the same or similar industries.
Pro tip: Build a well-researched and diversified dividend stock portfolio if you choose. To do so, use the Simply Investing Report and Analysis Platform.
Simply Investing provides up-to-date metrics for all the best dividend stocks. And recommendations on the best times to buy them.
Next, is an important reason why dividends don’t matter…
9. Loss Of Focus On Total Investment Returns
Sometimes dividend investors get so focused on dividend yield. And making the next dollar of dividend payments. They lose sight of the big picture.
Where the goal is to earn the greatest possible long-term total return on investment over time. Generated by both dividends AND capital gains.
Also, by minimizing investment fees and income taxes.
And speaking of your taxes. Here is number 10 on our list of reasons why you should not buy dividend stocks…
10. Dividend Income Is Not Tax-Efficient
It is the tax impact of dividends versus capital gains.
Because income taxes are due on dividends when they are received. Even if you choose to reinvest those dividends automatically right back into the stock that paid them.
As a result, all or part of your investment return is taxed immediately. Reducing the value of your investments. Thus, providing less capital to compound into the future.
This is one of the big selling points of stocks without dividends.
Conversely, a benefit of growth investments is the tax efficiency they provide. Since taxes are only due if and when a growth investment is sold.
In other words, when a capital gain is realized. An action, you as the investor, have complete control over.
Pro tip: Put your investments in a Roth IRA. By doing so, taxes will never be due on your investment returns.
Okay. That’s all I have for you today.
So, allow me to wrap up with a few parting thoughts…
Reasons Why You Should NOT Buy Dividend Stocks
Investors should be wary of stocks that pay dividends for a variety of reasons. First of all, chasing dividends, especially high dividend stocks, without a firm understanding of the drawbacks is a bad strategy.
Furthermore, investment risks associated with dividend-paying stocks are real. And dividends can be reduced at any time. As a result, dividend investors can suffer irreversible losses in some circumstances.
So, do your research. Understand what you are investing in and why. Learn and use the best practices and best tools in personal finance.
After all, it’s your money!
Of course, I can come up with dozens of reasons why investing in dividend stocks is good. And you can find many of those reasons in the articles located here…
…but were afraid to ask.
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.