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An Uncomfortable Truth About Dividends...
Published 1 day ago • 4 min read
Here's your weekly helping of interesting investing information and insights.
Food For Thought
You love it when dividends hit your account. I love it. Even John D. Rockefeller loved it. If you're reading this, you probably have a passion for passive income.
But there's something I wish I knew on day one...
Dividends DO NOT increase your net worth.
Dividends are a net-worth-neutral event (not including any taxes you might have to pay).
Wait. What?! Dividend checks don't increase your net worth?
Yup.
On most occasions, when a company earns money, they hopefully retain a portion of those earnings after deducting the costs of running the business. Surprisingly, this is called "retained earnings." 😉
If a company decides to pay a dividend—say, $1.00 per share—they declare it, and then the stock hits its "ex-dividend" date. This is the cutoff date. If you buy the stock on or after this date, you don't get that specific payout.
And guess what happens next...
Because the stock is now trading "ex" (without) that $1.00, the stock exchange automatically adjusts the opening price of the stock downward by exactly $1.00 on the ex-dividend date.
All that happened was the company moved $1.00 per share from its balance sheet to yours. Absolutely no wealth was created for you.
Seriously.
But wait, there's more!
Because dividends are taxable, the company is essentially forcing a taxable event on you, whether you like it or not. Whether it’s Uncle Sam in the U.S., Tío Sam in Spain, or Onkel Sam in Germany, governments around the world will want their cut.
So to recap: a dividend is a forced taxable event that is net-worth neutral. The company you own decreased its balance sheet by the exact amount of that dividend, leaving it with that much less to reinvest into the business.
Really sounds like I'm trashing dividends here, right?
Yes and no.
The point is to realize that dividend checks aren't magic money making you wealthier. Every penny sent to you is one less penny that can be reinvested into the company.
Over time, they can absolutely be part of a healthy, balanced financial diet... especially when they're paid by healthy, growing companies.
That last part is key. Dividends should be the cherry on top—the byproduct of a business that is drowning in cash and has plenty left over after funding growth.
The big mistake I made early on was just buying high dividend yields without looking into the company's fundamentals.
My oh my, have we come a long way. I'm much more "yield agnostic" now, often buying companies with a starting yield of less than 1% but very fast dividend growth—like Kinsale Capital (KNSL) at 0.32%, or Microsoft (MSFT) at 0.93%.
But old habits die hard. I still keep some guilty pleasure, high-yield companies in my portfolio, like Ares Capital (ARCC) at 9.97% and VICI Properties (VICI) at 6.31%.
The difference between then and now? I understand the mechanics of dividends deeply, and I consciously allocate my portfolio instead of chasing yield blindly.
We received $116.23 in dividends this week, but our net worth did not increase by $116.23!
Fortunately, companies with constant cash flow will eventually refill that bucket, and the cycle continues.
If you made it this far, just know there are many nuances and everyone's situation is different. Psychology plays a big part; dividend-paying companies "trick" many investors into happily holding through market selloffs.
Not to mention, when it comes time to live off your investments, many retirees love never having to sell shares to pay the bills—or to fund a night out at a fine RCI Hospitality (RICK) establishment.
I'd love to know if you learned something today, or if you absolutely despised this and are already looking for the unsubscribe button.
Hit REPLY and let me know. I respond to every email.
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300 episodes of The Dividend Talk podcast! The guys were joined by Nelson from Canadian Dividend Investing and Luke from Wall Street Wildlife. Investing talk and a few adult beverages to boot. Check it out!
Disclaimer: This is not investment advice. Do your own research before making any investment decisions.
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Each week you'll learn how to be a better dividend investor and follow the journey of a welder with a passion for passive income to $1,000,000 and beyond.
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