Dividends on investments are like the cherry on the cake. Investors look forward to dividends first and the principal amount later. Dividends indicate a steady flow of income quarterly, biannually, or annually.
Some investors cash in their dividends, while others reinvest them to either purchase new stocks or funds. Stable and profit-yielding companies pay good dividends to keep their shareholders happy.
Problems with dividend investing
It is a trend among investors to rollback their dividends for more stocks or funds. It is a good way to put money in the market, instead of holding it. But overall, the scenario is not as rosy as it seems.
High investment cost
High-dividend-yielding funds are associated with higher operational costs. So it is only natural that an investor will pay more dollars just to enjoy good dividends. By contrast, if the investor were to place the same amount in low-cost funds or stocks, his earnings could increase considerably.
High dividend yield
Higher dividend yield does not necessarily translate into good returns or performance. By contrast, low-dividend-paying companies consistently outperform and give good results.
Improper asset allocation
The problem with dividend investing is that one cannot diversify their assets based on risk and performance. If you only invest in stocks or funds that yield good dividends, you are missing out on other stocks that perform well but do not pay good dividends.
Risky strategy
Investing in dividend-yielding stocks is good but overinvesting in them is a very risky proposition. History shows that dividend-yielding companies tend to perform poorly on the stock market.
More taxes
One cannot ignore the fact that dividend investment attracts higher taxes. Investment returns take a back seat because you end up paying taxes on dividend-paying investments held for over a year.
Lack of funds
Fund companies are not showing much interest in dividend investment schemes. Dividend investment funds are saddled with a lot of baggage. The Vanguard Group of companies has stopped accepting dividend investment funds. Fund managers feel that because many investors roll back their dividends into the funds, and there are fewer new investment opportunities.
Compounding interest
Dividend investment works only for two types of investors – young investors who have time on their hand and retirees who want steady income. The power of compounding interest indicates that the more time you stay invested, the more your investment will earn for you. For investors who want liquidity in their funds, dividend investment is not the right vehicle.
Less cushion for companies
Most investors shy away from companies or stocks that churn out profits just to pay dividends to their shareholders. This is because if a company’s sales are low, their profits will decrease, and the company will not have any cushion to save face.
Dividend investments survive mainly on emotions, but they are not practical decisions. So, in sum, although dividends are good for any investment, it is always smart to look at the bigger picture such as total return on investment.
