• Dividend Investing:
  • How Dividends Affect Stock Prices With Examples [Investopedia]
  • Why Do Companies Pay Dividends?
  • Dividend Investing to Create Retirement Income
  • S&P 500 High Dividend Index: A Slice of Dividend Accounting
• Meb Faber’s Research:
  • Is the Best Dividend Strategy to Avoid Them? (Cambria)
  • What You Don’t Want to Hear About Dividend Stocks
  • Dividend Stocks Are the Worst
  • How Much Are Those Dividends Costing You
  • The Dividend Growth Myth
  • Think Income and Growth Don’t Exist in This Market? Think Again.
• Total Return Investing
  • How to Use a Total Return Approach for Retirement Income
  • Yield vs. Total Return
  • Understanding the Tradeoffs of Total Return and Income Investing
  • Why Take Sides
• 87% of Pre-Retirees Are Concerned About How to Generate Retirement Income

Hey, everyone, two quick things before we get into today’s episode. First, a reminder that you can always email me directly at podcast@youstaywealthy.com with any questions you think I can help with. I read and respond to every single one. Just know that clients are my priority and reply time does vary throughout the year. But I will get back to you.

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Let’s get into today’s episode. Retirement takes away something most people don’t realize they’re deeply attached to. For 30 or 40 years, money simply showed up.

Every two weeks, a paycheck hit your account. You didn’t have to decide when to create income, how much to take, or whether markets cooperated. It was automatic.

And then one day, it stops. Now, you’re staring at a portfolio and asking a much harder question. How do I turn this into reliable income for the rest of my life without overpaying the IRS or outliving my money?

If that feels uncomfortable, you are not alone. Nearly 90% of pre-retirees say they’re concerned about how to generate income once they stop working.

And when 6,000 investors were asked how they’d prefer to fund their retirement, 61% of them chose dividends and interest. Only 9% chose capital gains. It’s not hard to understand why. Dividends feel like the closest thing to a paycheck that retirement offers. But retirement income planning isn’t simply about generating cash flow.

It’s about creating sustainable income from a finite pool of capital over an uncertain time horizon while thoughtfully navigating around taxes, Social Security decisions, Medicare premiums, and the rest of your coordinated retirement system. And what feels safe and what actually improves long term outcomes are not always the same thing.

So in this episode, I’m going to walk you through what new research concludes about dividends, why the most popular retirement income strategy may not be the most efficient one, and what the evidence suggests about building a portfolio and a plan that actually supports long term retirement success. Because when it comes to funding your retirement, small structural decisions compound into very large outcomes.

Welcome to another episode of the Stay Wealthy Retirement Show. I’m your host, Taylor Schulte, and every week, I tackle the most important financial topics to help you stay wealthy in retirement. And now on to the episode.

The Retirement Income Mistake That Costs Investors Up to 6% Per Year

Cambria Investments recently published a fantastic research paper that measures the performance of different dividend investing strategies. And it very clearly reveals that high-dividend stocks have historically outperformed the broad US stock market. In fact, since 1974, a high-dividend portfolio generated an average annual return of roughly 14% compared to about 11% for the S&P 500. 3% outperformance per year. Not something that you could ignore, yet that giant gap is where most articles stop the analysis.

And when you combine those numbers with the emotional appeal of dividends, I can absolutely understand why so many retirees are attracted to this investing strategy. Because think about what retirement actually takes away from you.

For 30 or 40 years, you had a paycheck. Every two weeks, money showed up. You didn’t have to think about it. You didn’t have to make decisions about where it came from. It was just there. And then one day, that stops. Suddenly, you’re staring at a lump sum of money, and you have to figure out how to turn it into income for the rest of your life.

That’s a difficult and terrifying transition, and on the surface, dividend investing promises to solve that problem perfectly.

You buy big name companies you know by name that pay healthy dividends, the checks show up every quarter, and it feels like you’ve replaced your paycheck without having to sell anything.

On top of that, the marketing around dividend investing is everywhere. Passive income, financial freedom, never worry about running out of money. Just about every mainstream media outlet reinforces the same message. So, you’ve got research showing 14% annual returns, the emotional comfort of regular income, and the psychological safety of never touching your principal.

When you put all of that together, dividend investing feels like a no-brainer retirement income strategy, which is exactly why what I’m about to show you is so frustrating.

Because despite everything that makes dividend investing feel right, there’s something happening underneath that many people miss. Most people think of a dividend as extra money. You open your statement, you see $100 dividend received, and it feels like your account just grew by $100. But that’s not what’s happening. A dividend is not new money being created.

It’s a distribution of company profits. It’s literally a slice of the company’s value being removed and sent to you as a shareholder.

And because that money is leaving the company, the stock price typically adjusts downward by the amount of the dividend paid. Think of it like slicing off a piece of birthday cake and putting that slice of cake on a separate plate. You didn’t create more cake, you just moved it.

So if your favorite stock is trading at $10 a share, and the company declares a $1 dividend, you’ll receive that dollar, but the stock price would typically adjust down to $9 on the day the dividend is paid.

You’re in the exact same financial position. You just moved a slice of your cake onto a different plate. Now, if you reinvest that dividend, nothing really changes. Your total investment value stays intact, but most retirees are not reinvesting their dividends. They’re spending them. They’re eating that slice of cake.

And here’s where things start to matter a lot more. Every time that dividend check shows up, the IRS sees income. And you owe taxes on it that year, whether you need the money or not. You don’t get to control the timing. You don’t get to defer it. You don’t get to wait for a lower tax bracket.

The company pays the dividend, it hits your tax return, and you pay the bill. Knowing this, the researchers behind the Cambria study asked the only question that really matters. What do you keep after the IRS takes its cut? When they modeled real world tax rates to that same high dividend strategy, the 14% pre-tax return fell to as low as 8.5% after taxes, nearly identical to the S&P 500 under the same assumptions. Let that sink in.

What appeared to be a 3% point annual advantage before taxes turned into a virtual dead heat after taxes. The dividend investor took on more complexity, had to navigate around more income and tax payments, and ended up in roughly the same place as someone who just simply owned a low cost index fund. And it doesn’t stop there. Tax drag compounds.

Every dollar that goes to taxes is a dollar that can’t grow for you for the next 20 or 30 plus years of retirement. It’s like a slow leak in a tire. You don’t notice it day to day, but over a long enough drive or time period, you’ll find yourself stuck on the side of the road. As the Vanguard research team put it, of all the expenses investors pay, taxes take the biggest bite out of total returns. And by the time most people realize what those dividend taxes are costing them, they’ve already given up years of growth.

They’ll never get back. Now, I can already hear some of you thinking, Taylor, most of my retirement dollars are in a 401k or an IRA. Dividends are not taxed inside those accounts, so what you’re saying doesn’t apply to me.

And yes, you are partially right. If most of your portfolio lives inside tax advantaged accounts, the annual tax drag I just described does not affect you in the same way. But taxes are only one part of this story, because even when we take taxes completely off the table, there’s still a fundamental problem with how dividend-focused investors build a portfolio and fund their retirement.

And what the researchers found when they tested that exact idea was one of the most compelling and surprising parts of the study.

So in the same study, over the same time period, the researchers asked a simple question. What if we keep the cheaper, undervalued stocks that dividend investors tend to own, but we ditch the highest dividend payers?

In other words, keep the part that historically drove returns, buying companies at attractive prices, and we remove the expensive part, the annual tax bill. Here’s what they found. Assuming the highest tax bracket, a value index that removed the top 25% of dividend payers delivered after tax returns around 14.5%. I’ll say that again.

Assuming the highest tax bracket, a value index that removed the top 25% of dividend payers delivered after tax returns around 14.5%. Compare that to the high dividend strategy we previously discussed that produced after tax returns of 8.5% under the same tax assumptions. Same general types of stocks, same decades measured, but one strategy gave up 6 percentage points per year purely because of how it was taxed. Even crazier, and this really blew my mind, a version that eliminated dividend paying stocks entirely still returned just over 13% annually.

Now, I know what you might be thinking, that sounds way too good to be true, and I’d be skeptical too, but here’s why it works. Dividend investing and value investing overlap heavily.

Historically, many dividend paying stocks have traded at valuation discounts to the broader market. Those discounts, not the dividends, those discounts are what drove the outperformance. The dividends are incidental. The value premium, that’s what the nerds call it, the value premium did the heavy lifting. But the dividend came with a built-in tax cost.

So by removing the dividend, while maintaining the exposure to discounted value stocks, investors captured the return premium without surrendering a portion of it to taxes every single year. Over a 30-year retirement, that gap compounds into a staggering difference. And before we move on, here’s why this matters.

Even if every dollar you own is inside a tax-advantaged account, if you’re building a portfolio inside your 401k or IRA and selecting funds based primarily on which ones pay the highest dividends, you may be taking on more risk and accepting lower returns without even realizing it. The reason many dividend strategies have looked good over time isn’t necessarily because of the dividends. It’s often because these strategies own companies that are priced cheaper than the overall market.

If that’s what’s driving returns, there are simpler and more effective ways to get that benefit than just chasing the highest dividend payouts. Many high dividend funds end up owning junky, slower growing companies, and sometimes those companies are paying big dividends not because business is booming, but because offering a high payout is what attracts investors.

A big dividend can look appealing, but it doesn’t automatically mean it’s a strong company. A straightforward approach owning solid companies at reasonable prices or using a few low-cost diversified funds to do that for you has historically delivered better results than focusing only on high dividends. And that’s true whether you’re investing in a taxable brokerage account, a 401k, an IRA, or a Roth.

So, if the math is this clear, why do so many retirees still build their entire portfolios around dividends? The answer matters because it ties directly to a much bigger investing mistake I’m going to walk through in just a moment.

So, the researchers in the study use a simple analogy to explain why retirees gravitate towards dividends. The Pepsi Challenge. Back in 1975, Pepsi ran blind taste tests, and over and over again, people chose Pepsi over Coke. But here’s the twist. Even though Pepsi kept winning the taste test, Coke continued to outsell Pepsi by a wide margin. In response, the researchers changed one variable.

They decided to show participants the soda labels before they began the taste test. And suddenly, preferences flipped. Most people chose Coke.

In other words, the brand overpowered their own taste buds. Dividend investing works the same way. The brand of dividends, passive income, steady checks, never touching principle, the brand of dividends creates a powerful emotional pull.

The perceived benefits are so powerful that it often overrides what the actual data shows. Investors fall in love with the story of dividends, even when the math tells a different story. And I’m not saying this to be harsh. I’m saying it because awareness changes behavior. Once you recognize that your instinct might be protecting a belief instead of evaluating evidence, you can step back and look at the numbers objectively.

And that shift from following what feels comfortable to following what the math actually supports is what separates retirees who optimize their wealth from those who unknowingly leave money on the table.

So the real question is not, are dividends bad? The real question is, are you loyal to dividend investing or loyal to the story you’ve been told about it? And the answer to that question changes everything about what you should do next. Because here’s the thing, dividends are not the villain. Dividend investing, again, is rooted in value investing, which has decades of academic support. The problem begins when investors chase yield instead of focusing on risk-adjusted total return.

Yield, the size of the income payout, is not the same thing as wealth creation. As Meb Faber has pointed out, if you’re going to buy dividend stocks, you need a valuation screen.

Otherwise, you end up owning the expensive, lower-quality names simply because they pay high income. Dividend yield by itself is a terrible way to build a portfolio. Selecting investments based on the amount of the quarterly check often leads to worse outcomes, not better ones. And you don’t have to take my word for it. Warren Buffett’s Berkshire Hathaway has almost never paid a dividend.

In fact, the company paid a single 10-cent dividend back in 1967, and Buffett later joked that he must have been in the bathroom when that decision was made. Think about that. One of the greatest investors of all time runs an enormously profitable company and chooses not to distribute those profits through dividends. Why? Because Buffett has long believed that reinvesting earnings back into the business will allow him to create more value and higher after-tax returns for his shareholders.

And the results speak for themselves in one of my favorite statistics I’ve shared a few times here on the show. Berkshire’s track record is so strong that even if the stock dropped 99% from here, it would still be ahead of the S&P 500.

That’s the power of keeping capital inside a thriving business and compounding it for shareholders rather than sending it out as dividends. And it’s the same principle retirees should apply when building their own portfolios.

So here’s the takeaway, and I want to make sure this is crystal clear. The goal is not to avoid every dividend paying stock. If a company that pays dividends earns its place in your portfolio because it’s a high quality business, trading at an attractive price, that’s perfectly fine. If a low cost index fund that distributes some dividends earns a place in your portfolio because it gives you proper exposure to an asset class that complements the rest of your holdings, that’s perfectly fine too.

The dividend yield of the stock or the fund just should not be the reason you buy it. For retirees who need income, and that’s most of you, you don’t need dividends to create it.

You can generate your own income through proper asset allocation and a flexible withdrawal strategy. And I know, really quick, some of you are thinking, look, I just spend whatever my portfolio pays out in dividends and interests, so I never have to worry about any of this. But that’s the thing.

When your income is determined by what your portfolio happens to distribute rather than what your retirement plan actually calls for, you’ve handed the controls over to a dividend schedule that knows nothing about your goals, your spending needs, or what’s happening in the rest of your financial life. A flexible withdrawal strategy puts your plan back in the driver’s seat. You decide how much income you need, you decide when to take it, and you decide where it comes from.

That might mean pulling from cash reserves or bonds in a down market instead of selling stocks at a loss. It might mean intentionally realizing some gains to fill up your 0% capital gains bracket.

It might mean adjusting your spending slightly based on how your plan is tracking. The point is, your retirement plan is making the decisions, not a dividend schedule. And for those of you with money and taxable accounts, there’s an additional layer of benefit here.

That control also allows you to coordinate withdrawals around your tax bracket, your Medicare premiums, and how much your Social Security becomes taxable. With dividends in a taxable account, you don’t control any of that. The income shows up, the tax bill follows, and you deal with the consequences. But regardless of what type of account your money is in, the principle is the same.

Total return, not yield, is what determines how much wealth you actually build and sustain over a multi-decade retirement. And that requires letting go of the emotional comfort of dividend checks and focusing on what actually determines long-term retirement success.

Look, I know, dividend investing sounds simple. Buy some companies you know by name, collect the checks, never touch your principle. But as we discussed today, retirement income is more than just generating cash flow. It’s about building a portfolio around quality and value, creating a dynamic withdrawal strategy that puts your plan in control, and coordinating all of it so your investments, taxes and income are working together, not against each other.

That’s exactly what our total retirement system is designed to do. It starts with tax planning, because every withdrawal decision, every income source, and every investment choice has a tax consequence. From there, we build a customized retirement paycheck so you know exactly how much you can spend each year without fear of running out. Then, and only then, we align your investments, not around yield or dividends or popular names, but around your actual retirement plan and goals.

If you’re nearing retirement or already in it and you want help building a coordinated retirement income strategy so you can spend time doing the things that you love most, my team and I would be grateful to have a conversation to see if we’re a good fit. You can click the link in the episode description right there in your podcast app to watch a short video of me explaining our process and book a call.

Thank you very much for listening. And once again, to view the research and resources supporting today’s episode, just head over to youstaywealthy.com/272.

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.