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  • In my last two videos I talked about high yield bonds and preferred shares.

  • These are two alternative asset classes that investors venture into when they are seeking

  • higher income yields.

  • I told you why you might want to avoid those asset classes.

  • Today I want to tell you why focusing on investing to generate income is a flawed strategy altogether,

  • and why a total return approach to investing will lead to a more reliable outcome.

  • Investors often desire cash flow from their investments.

  • There are blogs, books, newsletters, and YouTube channels dedicated to income investing.

  • Income investing means building a portfolio of dividend paying common stocks, preferred

  • stocks, and bonds in an effort to generate sufficient income to maintain a desired lifestyle.

  • The idea is that if you have enough income-paying securities in your portfolio, you will be

  • insulated from market turbulence and can comfortably spend your dividends and coupon payments regardless

  • of the changing value of your portfolio.

  • There is a perception that if you never touch your principal, you won't run out of money.

  • It seems like a fool-proof retirement plan.

  • But is it, really?

  • I'm Ben Felix, Associate Portfolio Manager at PWL Capital.

  • In this episode of Common Sense Investing, I'm going to tell you why income investing

  • will not give you more income.

  • This video is in response to a question from Joey, who contacted me by e-mail.

  • Let me start off by saying that there is no evidence that dividend paying stocks are inherently

  • better investments than non-dividend paying stocks.

  • There are five factors that explain the majority of stock returns.

  • Dividends are not one of these factors.

  • For example, we know that if you gather up all of the small cap stocks in the market,

  • they will have had higher long-term returns than all of the large cap stocks in the market.

  • Based on this, company size is one of the factors that explains stock returns.

  • The same evidence does not exist for dividend paying stocks.

  • If they aren't better inherently investments, why do people like them so much?

  • In a 1984 paper, Meir Statman and Hersh Shefrin offered some potential explanations for investors'

  • preference for dividends.

  • If they have poor self control, and are unable to control spending, then a cash flow approach

  • creates a spending limit - they will only spend income and not touch capital.

  • Another explanation offered in the paper is that people suffer from loss aversion.

  • If their stocks have gone down in value they will feel uncomfortable selling to generate

  • income.

  • On the other hand, they will happily spend a dividend regardless of the value of their shares.

  • There's a problem.

  • As much as a dividend may seem like free money, the reality is that the payment of a dividend

  • decreases the value of your stock.

  • If a company pays twenty million dollars to its shareholders as a dividend, the remaining

  • value of the company has to decrease by twenty million dollars.

  • The investor is no better or worse off whether the company that they invest in pays a dividend

  • or not.

  • This is known as the dividend irrelevance theory, which originated in a 1961 paper by

  • Merton Miller and Frank Modigliani.

  • I have just told you that whether returns come from dividends or growth does not make

  • a difference to the investor, but there is an important detail for taxable investors.

  • There is no difference whether returns come from dividends or growth on a pre-tax basis.

  • On an after-tax basis, the investor without the dividend is in a better position because

  • they could choose to defer their tax liability by not selling any shares if they don't

  • need to cover any spending.

  • The dividend investor is paying tax whether they spend their dividend or not.

  • This is a big problem for an investor who does not need any income at that time.

  • About 60% of US stocks and 40% of international stocks don't pay dividends at all.

  • Investing only in the stocks that do pay dividends automatically results in significantly reduced

  • diversification.

  • Dividend investing can also lead to ignoring important parts of the market.

  • There are plenty of great companies that do not pay dividends.

  • Ignoring them because they do not pay a dividend, which we now understand is irrelevant to returns,

  • is not logical.

  • A good example of this is small cap stocks.

  • An income-focused investment strategy will almost certainly exclude small cap stocks,

  • few of which pay dividends.

  • Now, don't get me wrong, dividends are an extremely important part of investing.

  • One dollar invested in the S&P/TSX Composite Price Only Index, so excluding dividends,

  • in 1969 would be worth $14.37 today.

  • The same dollar invested in the S&P/TSX Composite Index, which includes dividends, would be

  • worth $64.59.

  • If you are investing in Canadian dividend paying companies, you also receive favorable

  • tax treatment on your dividend income.

  • Dividend paying common stocks are an important part of your portfolio, but a dividend-focused

  • portfolio leads to tax-inefficiency for taxable investors, poor diversification, and missed

  • opportunities.

  • A total-return approach, accomplished by investing in a globally diversified portfolio of total

  • market index funds, results in greater tax efficiency, better diversification, and the

  • ability to capture the returns that the market has to offer.

  • The topic of dividends tends to get people very excited.

  • Dividend investing is almost more of a lifestyle than an investment philosophy.

  • I would be happy to hear your thoughts in the comments.

  • Join me in my next video where I will tell you why active fund managers don't protect

  • you in down markets.

  • My name is Ben Felix of PWL Capital and this is Common Sense Investing.

  • I'll be talking about a lot more common sense investing topics in this series, so

  • subscribe and click the bell for updates.

  • I want these videos to help you to make smarter investment decisions, so feel free to

  • send me any topics that you would like me to cover.

In my last two videos I talked about high yield bonds and preferred shares.

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Why Income Investing Will Not Give You Income | Common Sense Investing

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    Joy Hsu に公開 2023 年 11 月 30 日
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