• Retirement Income Series
  • Part 1: Why Most Retirees Never Draw Down Their Savings
  • Part 2: The 4% Rule + Why the Creator Doesn’t Follow It
  • Part 3: Immediate Annuities and Dividend Stocks + Their Pros & Cons
  • Part 4: Using Dynamic Withdrawal Strategies to Maximize Income
• Total Return Investing
  • How to Use a Total Return Approach for Retirement Income [Schwab]
  • Yield vs. Total Return [Investopedia]
  • Understanding the Tradeoffs of Total Return and Income Investing [First Ascent]
  • Why Take Sides [Morningstar]
• Dividend Funds and Resources
  • Schwab U.S. Dividend Equity ETF
    • Methodology: Dow Jones U.S. Dividend 100 Index
  • Schwab International Dividend Equity ETF
  • Cambria Shareholder Yield ETF
  • How to Create Your Own Dividends
  • History of Dividend Growth Rates
  • A History of the S&P 500 Dividend Yield
• Stock Buybacks
  • Buyback Excise Tax: The Effects on Shareholder Tax Burdens and Federal Revenues [Wharton]
  • Lawmakers Don’t Understand Stock Buybacks
  • Stock Buybacks Are Devilishly Abused
  • Are Stock Buybacks a Good Thing, or Not?
  • Making Sense of Stock Buybacks

Dividend Investing (Part 4): Answering Top Listener Questions

Taylor Schulte: Hey everyone, really quick before we start the show, today is the final episode of my dividend investing series. As a thank you for listening and sending in your great questions along the way, I’m giving away 25 copies of one of my favorite investing books, The Investment Answer. 

The book is simple enough for novice investors to understand, yet dense enough to satisfy all the investment nerds out there looking to expand their knowledge. It’s also incredibly actionable and designed to help investors implement a properly diversified portfolio.

As I’ve done in the past, to claim your free book, all I ask is that you leave a written review of this show in the Apple Podcast app. Take a screenshot of your review and send it to podcast@youstaywealthy.com, along with your preferred version of the book (ebook or hard copy). Leaving a written review is an easy and free way to support my work and helps other retirement savers like you discover the podcast. 

Again, just send a screenshot of your review to podcast@youstaywealthy.com along with the version of the book you prefer and we’ll get your copy out to you ASAP. Ok, onto today’s show.

Welcome to the Stay Wealthy podcast, I’m your host, Taylor Schulte, and after receiving dozens of great listener questions throughout this dividend investing series, I decided to answer some of the best ones live on the show for everyone to hear. 

Questions like:

• If dividend investing is not a great way to create retirement income, then what is?
• What are some good dividend-focused funds to consider if an investor strongly believes in dividend investing? 
• What is the counterargument for stock buybacks? Why are some people against them?

To view the research and articles supporting everything discussed in today’s episode, just head over to youstaywealthy.com/220.

Our first question comes from long-time listener Jacob T. in Pittsburgh. Jacob asked: 

“In one of your recent episodes, you said that the dividend yield of a portfolio is irrelevant or not important. If that is true, then how does someone invest for income in retirement? I was always told that spending the dividends from my investments is an easy way to create retirement income and avoids having to spend down principal.”

First and foremost, great question, Jake. I appreciate your regular emails and appreciate you bringing this topic to the table since I didn’t cover it in great detail during this series. Part of the reason I didn’t cover it in detail is that I published a four-part series on retirement income a couple of years ago, which is still very relevant today. If you missed it or want to listen again, I’ll provide the links in today’s show notes. 

But to answer your question, it, of course, depends. In short, determining how to invest for income depends on three things: 1) Your philosophy 2) Your income needs and 3) Your tax situation and retirement goals.

#1 is simple. As I’ve said many times before, the best investment philosophy is the one you can stick with. While it may not be the most optimal, if investing in a sound dividend portfolio and spending the dividends you receive to pay for living expenses resonates the most with you, aligns with your preferred investment style, and is the strategy you can most likely stick with for a long period of time, then perhaps it is an approach for you to consider – perhaps it is the best way for you to create an income stream in retirement.  

#2 – Your income needs. Since I don’t believe in trading individual stocks or targeting investments with the highest dividend yield, I’ll use the S&P 500 to help explain my thoughts here. First, the current yield of the S&P 500 is roughly 1.3%. 

If you expand overseas and invest globally via something like the Vanguard Total World fund, the current yield jumps up to about 2%. Will a 2% yield provide enough cash flow to meet your income needs? Possibly. But, if not, thankfully, today’s unique interest rate environment provides you with some safe income alternatives– like CDs and treasury money market funds – that have yields closer to 5%. 

Now, while that’s good news here in the near term, those higher yields on virtually risk-free assets likely won’t last forever, so we have to be careful about getting caught playing a market timing game and stay focused on a long-term investing plan that is sustainable through all market environments. 

So, with the long-term plan in mind, perhaps you decide to create a simple investment mix of CDs and global stocks, and, as a result, you’re able to boost your portfolio’s yield to, let’s say, 3.5%. Will a 3.5% yield meet your income needs? If not, you’ll be required to take more risk – potentially an inappropriate amount of risk –  to achieve a higher yield. And this is one of the key risks of targeting yield to create retirement income – it can lure an investor into taking more risk. 

Now, if a 3.5% yield does meet your income needs at the moment, that’s great news. However, as I just noted, it’s likely that yields will come down on safe assets like CDs and money markets in the not-so-distant future, so we have to take that likely possibility into consideration. We also need to consider the dividend growth rate of the stocks in the portfolio. I.e., At what rate are the dividends in your portfolio growing? 

The good news is that, since 1950, dividends paid by companies in the S&P 500 have grown, on average, by close to 6% per year, well above the average annual inflation rate during the past seven decades. 

In other words, dividend growth rates have exceeded the rate at which prices have gone up. While dividends from the S&P 500 are far more likely to go up than down, when they do go down, or when their annual growth rates DON’T outpace the inflation rate, your dividend income plan may quickly break down.

During those difficult times, you may be forced to make reactive changes to your portfolio, alter your investment strategy, and/or take more risk in order to maintain your target yield, all while the markets and economy are potentially going on a wild ride. 

Personally, for myself and my clients, I want to do everything we can to avoid letting the current market environment force us to change our long-term investment approach and change the level of risk we are targeting. Chasing investment fads, or in this case, chasing yields (and relying on those yields to fund retirement expenses) can expose us to more risk and force those unwanted changes at less-than-ideal times. 

The third thing that will heavily influence how to invest for retirement income is your tax situation and retirement goals. As highlighted in this series, dividends are not very tax-friendly. More specifically, research has shown that, depending on an investor’s tax profile, the tax drag on a dividend portfolio can reduce returns by up to 1.5% per year. And, as I’ve discussed countless times throughout the history of this show, your retirement goals (i.e., your diagnosis) are what should drive your investment strategy (i.e., your prescription). 

Most people get this wrong. Most people tend to get hyper-focused on finding good or interesting investments without truly understanding what their retirement goals require and if those investments contribute to or hinder their unique goals. This is akin to taking what seemed like a fitting prescription without talking to a doctor and knowing if it’s appropriate for you, your symptoms, and your health history. 

Your diagnosis – i.e., your retirement plan and goals – should directly influence how you invest your money. Retirement income might be one goal, but perhaps you have other goals that need to be taken into consideration. Goals like charitable giving, or leaving a sizeable tax-friendly bucket of money to heirs, or paying for a family member’s education. 

Or, perhaps you want to die with zero dollars and your goal is to maximize spending without putting your long-term plan in jeopardy, especially early on in retirement. These goals will (and should) influence how you invest your money and dictate whether or not spending from a dividend-focused portfolio is even remotely appropriate for you.

Setting insurance products like annuities to the side, at the end of the day, investors have two choices when it comes to creating a retirement income plan – they can spend from the yield their portfolio happens to be producing at any given time OR they can allow their needs and goals to influence the construction of the most appropriate investment portfolio and create their own income strategy. 

The latter is my preference and is commonly referred to as total return investing. With total return investing, you allow your risk tolerance, risk capacity, and retirement needs and goals to drive how you construct your portfolio. A properly constructed portfolio will naturally pay regular dividends, but those dividends will not influence how the portfolio is constructed. 

A total return investing approach acknowledges that returns come from a combination of dividends, interest, and capital appreciation and, as a result, considers all sources of investment returns when creating an income plan. And, research has shown that this approach – when implemented properly – helps minimize portfolio risk and maintain portfolio longevity. How exactly does it minimize portfolio risks? 

Well, as previously noted, when you focus on spending from dividends, it’s highly likely that you will go through periods where you are forced to take on more risk to get the yield you need, leading to inappropriate risk exposure. 

Total return investing helps to avoid that by letting your unique goals and income needs inform the asset allocation. It also permits you to spend from both yield and capital appreciation, instead of just relying on the yield. 

Total return investing can also potentially provide you with more tax efficiency, given that the portfolio will likely have a higher percentage of the often-more-friendly capital gains taxes versus ordinary income. Lastly, total return investing provides a lot more flexibility when it comes to taking portfolio withdrawals. 

Instead of being forced to spend the yield from all asset classes in the portfolio, with total return investing, you can choose what investments to draw from when withdrawing your retirement paycheck each month or quarter or year. 

For example, if international stocks are down but U.S. stocks are up, then you can leave your international funds alone, reinvest whatever dividends they’re paying, and sell some of the appreciated U.S. stock funds to fund that quarter’s retirement paycheck (a systematic version of selling what’s gone up and buying or hold what has gone down). 

These benefits of total return investing all help to improve the longevity of a portfolio when compared to spending from dividends only, as shown in research published by Vanguard and others. 

This, of course, is a big topic, and there is a lot more to understand and take into consideration before you decide what is the most appropriate retirement income strategy for you. So, if you want to further explore dividend investing versus total return investing and how to create a reliable income stream, I’ll provide some articles and research in today’s show notes for you to review.

But, to summarize, yes, dividends will contribute to the returns of the portfolio and the income needs of the investor. I just don’t believe it’s prudent to choose an investment or a portfolio because of the dividend yield for all the reasons discussed today and throughout this series. 

Thanks again Jacob for the great question.

Our next dividend investing question comes from Marie S. out in Tampa, Florida. Marie writes:

“Thank you, Taylor, for all that you do. I’ve binged every episode of the podcast and am really enjoying your dividend series. I’ve always been a dividend-focused investor but your recent comments about ensuring I’m buying good companies at good prices really resonated. If I am going to continue buying dividend stocks but also want to make sure I am not buying junky overpriced companies, what are some options for me to consider? Are there any funds or ETFs you know of that pay healthy dividends but also focus on only buying good companies at good prices?”

Thanks, Marie, for your question. I considered including a discussion on potential investment products to consider throughout this series, but hesitated because I just didn’t feel like I would be able to properly address all the nuances without going really deep down the rabbit hole. 

But I wanted to address your question in this episode for two reasons: 1) The investment landscape is giant and confusing and leaves many investors feeling paralyzed and  2) While I shared a lot of information about dividend investing, I didn’t provide many ideas to help listeners take action.

To preface my response, the following is for informational purposes only and should not be considered investment advice. Please speak to your trusted advisors before taking action. Also, I don’t invest in any of the securities mentioned myself or on behalf of my clients. These investments aren’t necessarily bad, they just don’t align with my philosophy and approach. 

Ok, so, to reiterate Marie’s question, she likes the idea of investing in dividend stocks, but realized she could probably be a little smarter about her approach. Instead of just buying companies and funds that appear to have healthy yields, she’s curious if there are any good investment solutions that produce meaningful dividend income but are also focused on avoiding overpriced companies that may introduce unnecessary risk. 

A few things to note before I share some actual potential solutions to consider:

1.) U.S. dividend yields are currently lower than dividend yields overseas. So, you may need to diversify globally with your dividend investing strategy in order to get a higher yield, and that may or may not align your investment philosophy. There are considerations when investing globally, including additional fees, taxes, and risks, so be sure you do your proper due diligence and talk to your trusted advisors before taking action.

2.) In general, what you will find if and when you do your own research, is that the higher quality dividend funds that do a good job of screening out junky companies, typically have lower dividend yields. If the high-quality dividend value funds have, let’s say, a yield of 1.5%, and you come across a dividend fund with a yield of 5%, it should signal to you that you’re taking more risk in order to obtain that higher yield. 

Again, this is one of the challenges with dividend investing – you may be forced to take more risk than you need or want in order to meet your income needs. 

3.) I highly recommend reading through the methodology of the dividend fund (or funds) you’re considering. More specifically, look for an explanation of how the fund selects what stocks to include and exclude from the portfolio. You’ll especially want to keep any eye out for commentary in the funds literature discussing their process for targeting high-quality companies trading at low relative prices. 

If the methodology is that the fund buys the 100 highest-yielding stocks in a particular sector, you may consider crossing it off your list. Again, while I don’t believe in dividend-focused investing, if you’re going to pursue it, it would be prudent to at least ensure you are avoiding overpriced, junky companies.   

4.) Dividend-focused funds are often more expensive to own than broad-based passive funds like the Vanguard Total Stock Market ETF. Higher fund fees reduce the yield and expected future return of the fund. So, while you likely won’t be able to escape higher fund fees, it’s wise to pay close attention to the total cost when doing your research. 

And this leads us back to one of the challenges with dividend investing – would you rather have a low-cost, lower-yielding portfolio with higher expected total returns or a higher-cost, higher-yielding portfolio with lower expected returns and potentially more risk?

Ok, with those comments out of the way, here are three dividend-focused funds that Marie might consider doing her own research on if she remains focused on investing for yield but wants to do a better job of avoiding overpriced, junky companies.

If Marie is solely focused on investing in the U.S. and not interested in going overseas, one fund to consider that checks some important boxes is the Schwab U.S. Dividend Equity ETF (SCHD). It’s extremely low-cost (only 6 basis points) and provides an attractive yield of 3.4%. While I believe there are better valuation methodologies, the fund does track the Dow Jones U.S. Dividend Index which has a published process for selecting dividend-paying companies based on their fundamental strength relative to their peers. 

The downsides of this fund are that it only owns 100 companies and it has significantly underperformed the S&P 500 on a total return basis since it was launched in 2011. So, investors enjoyed a nice yield over the last 13 years, but missed out on over 75% of returns, when compared to the S&P 500 on a total return basis. 

If Marie is open to investing globally, she may consider Schwab’s international version of the previously discussed ETF. The fund is called the Schwab International Dividend Equity ETF (ticker SCHY) and while the expense ratio is a little higher at 14 basis points, the current dividend yield is about 4.5%. 

Unlike many international dividend funds, this fund has a decent amount of assets under management, roughly 741 million as of this recording. Higher assets under management improve the trading liquidity of the fund and improve the odds that the fund will stick around and not be closed in the near future. 

The downsides with this fund are similar to the U.S. version, in that it only holds about 100 securities. In other words, it’s not broadly diversified. In addition, the fund is fairly new, with a launch date of 2021. That’s not necessarily a reason to avoid the fund, but would be an important consideration when doing your due diligence.

Lastly, if this series has Marie thinking about dividends a little differently and is interested in a fund with a unique approach to yield, she might consider Cambria’s Shareholder Yield fund (SYLD). This fund focuses on high-cash distribution companies that are returning their cash to investors in three ways – dividends, stock buybacks, and debt paydown. 

Collectively, these three attributes are known as shareholder yield. But, as discussed in our dividend investing series, returning cash to shareholders through something like a stock buyback doesn’t show up the same way dividends do. Stock buybacks contribute to the total return of the fund, but not through a dividend payment. 

With that in mind, it shouldn’t be a surprise that the dividend yield of this portfolio is only about 1.9%. But the fund manager argues that companies that have high shareholder yields trade at a valuation discount and therefore have higher expected returns than companies strictly focused on paying traditional dividends. 

So, lower dividend yield, but a higher quality portfolio of stocks and higher future returns is what this fund aims to deliver. The fund has attracted more than $1 billion and has slightly outperformed the S&P 500 since launching in 2013. 

One of the major downsides with this fund is the expense ratio of 0.59%, which is significantly higher than the other two funds mentioned as well as other competitive value-oriented funds like those offered by Avantis that hover closer to .20% or .30%.  

A lot of considerations here, but hopefully, I’ve given Marie and the listeners some actionable ideas to consider. Even more, I hope my comments about these funds, coupled with your own research, reinforce what I’ve been emphasizing throughout this series – that targeting investments just for their yield may not be the most appropriate strategy. 

That dividends are nothing special, and letting them influence your investment selection may lead to sub-par returns, more risk, and potentially higher taxes.

QUESTION 3 – 

Ok, the last question comes from John S. in New Jersey. John writes,

“Hey Taylor, I really enjoyed learning more about stock buybacks in this series. I’ve struggled to understand them and appreciate your simple explanation. You mostly shared why stock buybacks are a good thing for investors, but I’m curious to learn more about why they have been under attack in recent years. For example, what is the goal of assessing a 1% excise tax on stock buybacks? Why would the president want to quadruple that tax to 4%?”

Thanks for the great question, John. I definitely should have discussed this in a little more detail, so I appreciate you reaching out and asking. 

First, as noted in the first episode of this series, one of the primary reasons companies commit to paying a healthy dividend is to signal strength to potential investors. That reason, while valid and very real, is kind of silly once you begin to understand what a dividend is and what alternatives companies have for sharing excess cash with investors. 

There are great companies that pay dividends, and junky companies that pay dividends. Just because a company pays a dividend, doesn’t necessarily indicate it’s strong and healthy. 

In recent decades, there have been a growing number of companies that are less concerned about paying dividends to signal to investors that the company is healthy. Instead, to share profits and excess cash with investors, they began engaging in stock buybacks, primarily because they were more tax favorable. 

As shared in the second episode of this series, the value of stock buybacks for S&P 500 companies has outpaced dividends every year from 1997 to 2023. This trend toward stock buybacks and away from dividends has put a dent in tax revenue for the U.S. government. In response, the Inflation Reduction Act of 2022 imposed a new 1% excise tax on buybacks. 

Even with that new tax, research has shown that, on average, buybacks still remain more tax favorable for domestic shareholders than dividends, hence why President Biden is calling on Congress to raise the tax to 4%. According to a paper published by Wharton, quadrupling the buyback excise tax rate would increase tax revenue by $265 billion over the 10-year budget window.

The other issue that people have with stock buybacks is that they benefit the company and existing shareholders more than workers and research and development. An often-cited example by those opposed to buybacks is highly profitable oil firms repurchasing their own stock and rewarding executives and shareholders instead of using profits to fund initiatives that could help improve the global energy crisis. 

So, to put it simply, in addition to an alleged loss in tax revenue, some believe that buybacks are the devil because they extract value from the economy rather than create it.

I think the proper response to the two opposing sides is the quote from Jason Zweig that I shared in episode two of this series: 

“Buybacks are neither bad nor good. They are simply a tool. Just as you can use a hammer either to build a house or knock one down, buybacks are useful in the right corporate hands and dangerous in the wrong ones.” 

Jason also made a good point in his article stating that discouraging buybacks doesn’t necessarily mean the company will allocate their excess cash in a more acceptable way. In other words, if you don’t trust a company to make the right decision with stock buybacks, why should you trust that the alternative they decide on is any better? 

If you want to dive deeper and come to your own conclusion, I’ll provide links to a few articles in today’s show notes that take different sides of the debate.

Once again, the show notes for today’s episode can be found by going to youstaywealthy.com/220. 

This wraps up my series on dividend investing. I appreciate you following along and sending in your comments and questions this past month. While I love nerding out on investing strategies, I’m excited to jump back into some retirement and tax planning topics that I know are important and relevant to our listeners. 

Thank you, as always, for listening, and I will see you back here next week. 

Episode Disclaimer: This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.