March 25, 2019 | 09:08 PM


07.12.2012Paying Dividends?

The idea high-dividend stocks are reliable for retirement cash flow is popular

Lara Hoffmans, Forbes.com

A key concern for many investors: If a fiscal cliff deal doesn’t happen soon, will higher corporate and dividend taxes hit retirees counting on dividend income particularly hard? A better question: If you need portfolio income, why are you relying on high dividends primarily? (A subject tackled in Plan Your Prosperity, the latest book I co-authored with Ken Fisher.)


The idea high-dividend stocks are reliable for retirement cash flow is popular—but potentially dangerous (as the current fiscal cliff kerfuffle underscores). If corporations must pay higher taxes, and income taxes rise for investors, that can provide a disincentive for firms to continue paying a dividend or, at least, paying a dividend as high. Already, some firms are making special (and larger) dividend payments this year to avoid potentially higher taxes in 2013.

There’s nothing sacred about a dividend. Firms can and will cut them or stop paying them altogether. A dividend is just another way for a firm to add shareholder value. Some firms see more value in retaining earnings and plowing them back into the firm—buying equipment, hiring, buying competitors, buying back stock, etc. Other firms, because of the nature of their business or where they are in their lifecycle, might find they can increase shareholder value by giving a valuable asset (i.e., cash) to shareholders. But if it doesn’t make economic sense to pay a dividend, firms may find a different use for that cash—buying back stock, for example.

Some folks think a dividend signals a firm is particularly healthy. Not so! PG&E had a long history of paying a dividend, but suspended it for four years after its stock price crashed in the 2001-2002 bear market. Its dividend yield even rose as its stock price plummeted. But that’s because dividend yield is a function of past payments and current stock price—that higher yield was a sign of a crashing stock, not increased corporate health.  Lehman Brothers (RIP) paid a dividend just weeks before it imploded. A dividend doesn’t signal sure safety—they can get cut or suspended, and dividend paying firms can go utterly bust.

That’s not the only danger of a high-yield only (or mostly) strategy. All equity categories rotate in and out of favor and none are inherently superior long term—and high-dividend stocks are just another form of equity category. Because firms that pay dividends tend to see more value in shipping cash to shareholders rather than reinvesting profits, high-dividend stocks tend to perform best when value stocks do.

If you’re in a period of value underperformance (when can last for agonizingly long periods) your high-dividend portfolio likely also lags the broader market, weighing on total return and, subsequently, your cash flow.

So what can you do if you need cash flow from your portfolio? First, in any well diversified portfolio, you likely will still have some dividend-paying stocks generating cash. But you can also sell securities. (My boss, Ken Fisher, calls this “homegrown dividends”—meaning you can stay optimally invested and mine cash from a portfolio however appropriate.) Stocks (bonds too) are cheap to buy and sell. Even if there’s no fiscal cliff deal (which I doubt), the long-term capital gains rate will still be cheaper than the income tax rate for most investors. You can also sell some down stocks to mitigate a tax bill (which may be a very attractive proposition to some investors very soon).

There’s nothing wrong with dividend-paying stocks. They will always make up a portion of the market, and likely should be in your portfolio. The problem is hamstringing yourself to high dividends only.

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