The Downsides of Dividend Investing

Dividend investing had much going for it. It is a simple method of building wealth. It is easy to understand. If one’s personality allows, it can be low stress, low risk, low maintenance, and methodical. (I love Oxford commas.)

And, IMHO, I prefer dividend investing. IMHO, it is better than any other method. For me, it reduces stress, it induces comfort, it lets me sit back and smile, it lets me avoid lots of noise, it lets me sleep at night, and so many other things. If I had an easy chair and if I liked coffee, I could say it lets me sit in my easy chair and enjoy my coffee.

Nonetheless, in fairness, it is true that nothing is all pure goodness and light. There are downsides to everything, including dividend investing. And for anyone embarking on any course of investing, it is appropriate to be aware of what they are. Not all of these downsides may apply to you, but you should be aware of them.

– It is slow. Slow means things generally only happen quarterly, when dividends are paid. Yes, everyone wants to “get rich quick,” and dividend investing by definition is slow. For the impatient, it can be excruciating to attempt dividend investing. In fact, since patience is required, there are personality types for whom dividend investing would be the wrong choice.

– It takes a long time. This is not the same as slow. A long time means it takes years of quarters to make substantive progress.

An aside
Slow and a long time are double-edged swords. The upside of slow and a long time is that one can invest for the future and also have the time to pay attention to other things. A patient dividend investor can put in a small amount of time paying attention to their investments, and have the rest of their time focused on other things, like family or career. A frequent trader needs to be focused on the market much of the time.

– You must be diversified. While many people hope for that one “big score” to transform their lives, dividend investing is, by definition, anti-big score. The dividend investor purchases shares with the intention of probably never selling. So the score is in the growth of dividend income. Since no one can know the future (namely, which companies will grow and which will fail), one must diversify. In such a case, one must spread one’s investible funds among many companies. The act of diversification tempers the entire thrust of “let’s hit a home-run” method of investing.

– If the dividend investor uses dividend reinvestment plans (DRIP), then accurate record keeping is extremely essential. Accurate record keeping is always essential for any investor in any security, but especially true for a dividend investor who uses dividend reinvestment. It’s a sad thing, but should you sell (or be forced to sell such as if a company if acquired for cash), for tax purposes each transaction needs to be accounted for as a gain or loss. A dividend purchase of fractional share[s] is such a transaction.

– Taxes. Dividends are taxed. For better or for worse, under current tax law, dividends are taxed at a lower rate than income from a job. (The history of varying tax rates on dividends makes for interesting reading, if you are into this kind of thing. See Wikipedia or Dividend.com.) Dividends are taxed regardless if received in cash or used to reinvest. If one receives dividends in cash, then part of that income can be used to pay the tax. However, if one uses all of the dividends to reinvest, then one must other funds to pay the taxes on the dividends.

– Little or no bragging rights. The only people to whom a dividend investor can share his or her excitement with is another dividend investor. Who wants to hear about “I have held this stock so long that my original tax basis is now one dollar”? I do, because someone told me that some years ago, and I was happy for them. But the average investor couldn’t care less about that, they want [to hear about] is a big score.

– Yields vary. While we might generally think that dividends (as an example, the average yield of the S&P 500) would out-pace U.S. Treasury notes and bills, this is not always the case. There have been years that U.S. Treasuries yield more than the average yield of the S&P 500. I would concur that for safety, nothing beat U.S. Treasuries. However, Treasuries are fixed rate and eventually mature, and you need to reinvest, which can be at a low rate time; whereas dividends adjust over time to the fundamentals in the economy and in the market. And Treasuries are bonds, subject to the risks of bonds.

Despite the downsides of dividend investing, I believe that for me dividend investing is the best and simplest way to grow wealth. There are alternatives, such as mutual funds and ETFs (especially index funds and ETFs), but then you have management fees and other considerations that may drag down your returns.

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