Dividends Anonymous
June 14th, 2006Hi, my name is Jeff Howard and I am addicted to dividends. The ideas behind investing in dividend paying stocks are not complicated but it is a broad and diverse subject. I could not possibly begin to give you all my reasons for loving dividends in one article so I am going to spread out the info over a period of days. I'll start with some brief ideas and then delve more thoroughly into them in other posts. As you can probably tell from the tone of my other posts I have adopted a sort of negative attitude towards all things fee related. I also have a sort of unique perspective on the future of world capital markets. A combination of those things and some other thoughts are what led me to the world of dividends. They seem to be the perfect tool for what I believe the future investment environment will look like.
The following list is not exhaustive. I will cover some other things in greater detail in the future. These ideas are a good starting point for understanding my thought process.
- No Faking - With the world now waking up to the ease of financial statement fraud (see Enron, Worldcom, and others) I find it very reassuring that it is impossible to fake a dividend payment. Now, you can fake all sorts of info related to the dividend but you cannot actually say you paid one and not pay it! Dividend paying stocks seem to have more mature accounting practices than other fledgling "growth" companies because they have to - dividends are paid out of excess cash and you cannot have REAL excess cash unless you account properly. If you want an even scarier story, read up on Barry Minkow and Zzzz Best Cleaning. In 1986 he actually took a company public that was completely fabricated with false financial statements. IPO anyone?
- More Predictable - dividend streams are much more predictable than capital appreciation. There are lots of companies that have been paying dividends and increasing that dividend every year for decades. Very rarely do the mature dividend paying companies ever reduce the dividend payment (but it does happen). In a future post I will give some evidence and examples of this. For now, just understand that dividend paying stocks have a much lower level of risk than do new growth companies.
- Recession Proof - dividends are still paid during recessionary periods or periods when the market is in a bear phase. This is great for two reasons. One, the dividend payment will decrease your losses from capital depreciation thereby increasing your long term compounded gain. Two, the distributions of dividends during these phases will give you money when you need it most - when stock prices are on sale and it's time to buy!
- Retirement - as a financial planner one spends a great deal of time talking about "nest eggs" and the size of the retirement pot necessary for someone to have before they head for the beach. With ever increasing life spans pictures of those nest eggs now look like giant dinosaur eggs. Try telling someone who makes $70K/year that they need $4 million to retire on - not fun. An intelligently built portfolio of mature dividend paying stocks can provide a real serious income in retirement WITHOUT the nest egg having to be gigantic. I will also share an example of this in a future post so that you can see what I am talking about here. Wouldn't it be nice to have a perpetual income stream from dividends without having to worry about diluting your capital base in your retirement portfolio?
- Taxation - as most of you are aware by now the tax on dividends is presently 15% and that rate has been extended by congress to the end of 2010. The old rate was whatever your ordinary income tax rate was. 15% is now equivalent to the tax on long term capital gains. Many people view the tax burden of dividend payments as a negative. I am not one of them. Wealthy investors would be much better off taking their dividends and having them taxed at 15% than waiting and hoping the rates will not go back up. Long term capital gains taxes have not always been as low as 15% either. Tax rates are an uncertainty going into the future but 15% is a reasonably low figure historically. Take it while you can get it. I also prefer the dividend payments BECAUSE they are paid quarterly and provide lots of flexibility to work with when rebalancing portfolios, etc. Much more on this later as well.
I am sure these few thoughts probably left some people with more questions. Hopefully I can address many of those in the coming series of posts on dividend investing. It may take a week or two to get everything into an article but I'll do my best.
"The compound nature of the dividends and capital appreciation of Merck for the last 25 years has just been far better than what Warren Buffet has done."
-Jim Cramer
Disclaimer: this post is for informational purposes ONLY. Please read the disclaimer before even thinking about relying on me to make a financial decision!
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