Vol 3, Issue 3. Quarter 2 – 2026.

We interrupt this program to bring you an important message that will really tick a lot of people off.

Many investors, and especially retirees love to talk about how they live off of dividends, and how this is the clear answer to the retirement income problem. Well, here is my take on that idea in three simple words – Dividends Don’t Matter!

Many of you are now asking yourself the age old question – “What’s wrong with this moron? How can getting a dividend check at the end of each quarter not matter?” Let me be clear. I am not saying that getting a regular check is a bad idea, or that I am sending the money back when I get it. I am simply saying that getting the return from the market in the form of a dividend check is no better than getting it through the rise in the company’s value.

Here is the math in an admittedly over-simplified form. A company hopes to generate returns that increase the “equity” portion of the balance sheet. This is simply the difference between assets and liabilities – the rough equivalent of your net worth. Do not get this twisted – More Net Worth is Always Good!!! The company increases the Shareholders Equity portion of the balance sheet through the profits that it holds on to. These are called “Retained Earnings” because that is literally what they are.  The earnings that are not paid out to shareholders.

The firm can take these retained earnings and spend them as management sees fit. They can use them to buy portions (or all) of other firms.  They can spend the funds to improve the business itself by investing in things like new facilities, equipment, etc. They can also buy back shares meaning they buy the company stock, or they can use the funds to pay dividends.

The reason they might use the funds to buy stocks in other companies is that they suspect that they can get a better return, or more likely because they see value in having a more diversified collection of assets. They are likely to invest in themselves when they believe that this will generate a return that exceeds their cost of capital. Both of these things happen in the normal course of business and are rarely newsworthy.

What you will see on your friendly broadcast about business in America is stories about when the firm announces that it will buy back shares of stock or increase a dividend payment. From the perspective of a long-term investor, these actions are almost exactly the same event. Here is why. Dividends are direct cash payments. They have no net impact on your position. (How can that be true you dummy?)

Let me explain. When the firm pays the dividend, it reduces an asset – Cash. But this does not eliminate any liability, because there was no law in place that stated that they had to pay a dividend. As a result, the outlay is simply a reduction in Shareholder’s Equity. It is like you moved money from one pocket to the other. You moved it from the balance sheet of a company that you own to your checking account. No real gain is created.

Think about 2 investors – Mr. A and Mrs. B. Mr. A owns a share of stock valued at $10 and gets a $1 dividend. The net worth of that company has just dropped by the $1 that went out the door. Mr. A now has $1 and a share of stock worth $9. Mrs. B simply holds a share of stock valued at $10 and the company holds on to that $1 in cash.  As long as $10 = $10 this leaves Mr. A and Mrs. B with the same net worth.

We recognize that Mr. A “Feels” different because he just got a $1 check while doing no work. This is a pretty cool way to live. Of course, Mr. B can always sell enough of the stock to get the exact same $1 but it doesn’t feel as cool. This is a result of what is often called “Mental accounting”. We account for money a bit differently depending on how we get it, or how we characterize it. A Dividend payment feels like free money, whereas proceeds from a sale feels like giving up the future gain on a stock by cashing out part of our position in the present.

But there is another key feature to recognize here. When you get the $1 dividend you pay taxes on that income instantly, whether you needed the money in your pocket or not. When you hold the stock, you decide when you will cash it in and you manage your tax liability accordingly. I will ultimately argue that this is an incredibly small benefit, but that is not to say that it is non-existent. (If you are a bit more clever, you can simply borrow money using the stock as collateral and pay no taxes, because debt is not treated as income, but that is a topic for a future post.)

Dividend payments are a portion of the total return from holding a share of stock. The price appreciation is the other portion. The argument made above can be restated as saying that if the total return is the same, there is no economic reason to favor one over the other.

Factor Analysis

Some or you will offer the more sophisticated argument that the long-term return on stocks that pay healthy dividends is better than the market as a whole. This statement has a grain of truth in it, but the reason may not be completely obvious.

Companies with a long track record of dividend growth tend to be companies that are highly profitable, with great cash flows, and conservative investment policies. These factors explain why they offer health returns over the long term. It’s not the dividend that drives this outcome because the dividend was part of the total return anyway. It is the company’s profitability that allows the dividend.

In addition, if you limit your focus to companies that pay attractive dividends you reduce exposure to very profitable companies that do not. A portfolio that focuses on dividend paying firms will ignore about 35 – 40% of the market. As a result, such a portfolio is less diversified than one that simply buys the entire market. In addition, dividend payments may not be as reliable as they are presented as being. In 2009 14% of firms eliminated their dividend, and 44% of firms reduced them.

If dividends play no outsized role in predicting total returns, we should see about the same annual total return from stocks that pay dividends and those that do not. Research from Dimensional Fund Advisors in 2013 found that the return on global, developed market, dividend paying stocks was the same as non-dividend paying stocks from 1991 to 2012. You should not read too much into this. If I chose a different period, I may see a positive difference or a negative one. The larger point is that, on the whole, across a long horizon, there is no good reason to believe that dividend payors are a better bet than the non-payors. In that sense – dividends don’t matter.

To be fair – There is a Bit More to the Story

If investing in stocks that pay handsome dividends has the side effect of causing you to avoid panic selling when prices go down – it may actually be doing you some good. But this good is not because of the dividend itself, it is because of its impact on your behavior. Another way to get the same effect is to consistently read the posts from your friendly neighborhood egghead (that would be me) that tells you the same thing. When you get that insight from me, it costs you nothing, does not reduce your level of diversification, and does not raise your tax bill. I think that I will quit while I am ahead and close with that.