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're
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 foolproof
retirement plan but is it really I'm
been 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
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this video is in response to a question
from Joey who contacted me by email 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
those 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 and all of the
large cap stocks in the market based on
this company size is one of the factors
that explain stock returns the same
evidence does not exist for dividend
paying stocks if they aren't inherently
better investments why do people like
them so much in a 1984 paper Meir
Statman and her schefren 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 is 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
medically Annie I have just told you
that weather 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 it's 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 $1 invested in the S&P
TSX composite price only index so
excluding dividends in 1969 would be
worth 14 dollars and 37 cents today the
same dollar invested in the S&P TSX
composite index which includes dividends
would be worth $64 and 59 cents 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 click the bell
for updates
I want these videos to help you make
smarter investment decisions so feel
free to send me any topics that you
would like me to cover
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