There are some passionate advocates for dividend stocks in the investing world.
In today’s episode, guest host Jeremy Schneider explains what dividends are and why he believes that chasing dividends will actually make you less wealthy in the long run.
He recounts an example told by Warren Buffett explaining why Berkshire Hathaway has never paid a dividend.
Jeremy also answers a user question about a better way to invest than the S&P 500.
How to Listen to Today’s Episode
Episode Links & Resources:
- 👉 Get Your One-Time Retirement Plan
- Jeremy Schneider
- S&P 500 stocks that don’t pay dividends
- Warren Buffett’s letter to investors [PDF pages 19-21 discuss dividends]
- Jeremy’s post on not chasing dividends
Why I Don't Buy Dividend Stocks
Jeremy Schneider: As Jack Bogle said, you don't want to look for the needle in the haystack, you just buy the haystack. That's kind of the concept behind an index fund. And then you own all the dividend and non-dividend producing stocks.
Welcome to the Stay Wealthy Podcast with Taylor Schulte. Once again, this is not Taylor Schulte. My name is Jeremy Schneider, filling in for Taylor for the month of July. This is my second of five episodes I'll be doing during July, and Taylor will be back on the mic in August.
If you want to find notes for the show, you can find them today at youstaywealthy.com/76.
Today I want to start with a bit of a trivia question. I'm going to name 10 stocks, and I want you to think about these stocks and try to figure out if you can tell what they have in common. They might have a few things in common because you can probably find some similarities with any 10 large publicly traded stocks. But these 10 have something pretty specific in common.
These companies are in alphabetical order, Amazon, Berkshire Hathaway, CarMax, Chipotle, Facebook, Google, Netflix, Salesforce, Under Armour and United Airlines.
Do you know what those 10 companies have in common? And then they're not the only 10 companies, but they are 10 very big successful companies that have this in common. If you read the title of today's show or if you looked at the show description already, you probably know that it has to do with dividends.
Those 10 companies have never paid a dividend, so a little bit of a spoiler alert there in the title, but those are some big profitable, successful, fast growing, very valuable companies, and they've never ever paid a penny in dividends. So today we're going to talk about dividend stocks and why I do not buy dividend stocks.
First, I always like to break things down simply. I'm a simple man, and complicated topics can overwhelm and confuse me. And so I like to start with the basic building blocks. And so what is a dividend? A dividend is a way that a company pays money back to a shareholder.
So if you buy stock in a company, if you want to buy a little piece of Apple or ExxonMobil or AT&T, you give the current shareholders some money, they give you the share, and then while you're the shareholder, the company can decide to, and the company is doing its business and profiting.
So Apple, for example, is selling a bunch of iPhones and making a bunch of money on iTunes or whatever, and then they have a bunch of money. They have a bunch of cash and profits they can choose, the company can choose to pay back their owners with a dividend, with a cash dividend.
And so if you have a stock sitting in your investment account, you have an Apple stock, for example, every quarter, I think they're paying dividends quarterly right now. There will be cash deposited your account for just owning that stock at that moment. It's a great way to realize some of the profits from a company.
So it's great. The concept is very cool. It's free money. So if you just have a bunch of dividend stocks sitting in your brokerage account, free money just gets deposited there on the dividend schedule of all these profitable companies. So the concentrated cool is very attractive. You don't have to sell your shares to get any money, you can just sell them forever.
And you know, I think there's a dream of living off the dividends as they say. So you just own the stock. You don't have to do anything. You don't have to buy or sell or trade or anything. You just get to get the free money and dividends.
So it's very, very attractive. Most big companies do pay a dividend in the S&P 500, most do, but 78 of the S&P 500 companies don't pay a dividend. So here's the problem. So they're so good. That's the idea.
You get free money just for owning the stock. So what's the problem? Here's the problem. When you try to chase those dividends, when you're only buying the stocks that have a big dividend or you're trying to best buy the best dividend stocks, what you're in essence doing is buying, is using less of your portfolio, using less of your money invested to buy every other stock. And so you are not buying those 10 great companies. I listed there, there's been a lot of talk about the faang companies, FAANG, which is Facebook, Apple, Amazon, Netflix, Google.
Those five have never paid a dividend yet. Those were five of the biggest companies in the world and five of the fastest-growing companies over the last 10 to 20 years. And so if you were chasing dividends, you would've missed out on that massive growth.
And those five companies for a few years there were providing most of the total growth of the S&P 500 alone, because those five were doing so well. So when you just chase dividends, you're missing out on those growth. That's one problem. The next problem with dividends is the value of those dividends is priced in.
So everyone knows that those companies are paying dividends. That's public information. And so when you go and buy that company, you're paying more in order to get that dividend, which is okay. It's a fair price. I believe that the market is very efficient, and so the price of the company is going to reflect the price of that dividend.
But it's not like you're getting a great deal. You're not gonna get this huge amount of free money. In fact, dividends for the whole S&P 500 right now are about 2%. So you're not getting massive amounts of money in dividends getting a small amount of money, and that's already priced into the price of the share.
And then the third problem with dividends is there's less diversification. So if you are just chasing those dividend stocks, you're gonna be buying a certain type of stock, usually a larger stock, usually an older company.
Usually certain industries like we just talked about, a lot of the fastest growing tech stocks in the last decade don't pay dividends. And so with less diversification, you might be exposing yourself to certain types of specific risk.
So if something weird happens, so for example, oil and infrastructure companies pay dividends usually, but if something weird happens to those industries, maybe your dividends go away, or maybe those share prices are hit more than the total market has hit. And so you're getting less defer. Less diversification means you're getting more volatility and more risk without more expected reward.
Normally when you invest, when you take on more risk, the results should be more reward, right? So I can take a no risk and put my money into a bank account, into a checking or savings account and have essentially no risk because that money is even insured by the federal government.
Or I can buy stocks and have more risk, but my expected reward is higher over long periods of time, my stocks will return more than my checking account. But if you buy just dividend stocks, you're kind of being less diversified, which gives you more of that specific industry risk without the expectation of more long-term growth.
Taylor Schulte: Hey everyone, I hope you're enjoying your time with Jeremy. I just wanted to pop in really quick and let you know that my firm is currently offering a free retirement checkup, which includes a 2019 tax return analysis.
As a reminder, we specialize in retirement planning for people over age 50 who have accumulated investments of $750,000 or more. If you're on the hunt for a retirement and tax planning expert and you want to learn more about our free checkup, just head over to definefinancial.com and click on the big purple button that says free assessment.
Again, that's definefinancial.com.
Jeremy Schneider: So you don't need to believe me, I wouldn't believe me. Who am I? I'm just some dude with an Instagram account guest-hosting a podcast. That's a pretty low bar, but let's go to someone else who probably knows a little bit better than me, a guy named Warren Buffett.
If you don't know Warren Buffett, I think he's like the second richest man in the plant at the moment. I think he often trades back and forth with Bill Gates, all, I guess Jeff Bezos is now more often number one. Warren Buffet is the CEO of Berkshire Hathaway.
One of the companies, which is famously never paid a dividend, and Warren Buffet has never written a book, but he does write these annual letters to his shareholders of Berkshire Hathaway, and those were actually compiled into a book it's called The Essays of Warren, and it's 328 pages of mind-numbingly boring letters that are like often super dry, sometimes actually kind of funny and cute, but often super dry and pretty high level and not a very interesting read.
And I read everyone else 328 mind-numbingly boring pages, and I'm going to boil down one interesting point for you right now, which is in his 2012 letter to the shareholders, he basically broke down in pretty explicit detail why Berkshire Hathaway never pays a dividend.
So he used, he described, or he made an example of a fictional company, which is a profitable company and growing at 12% per year. And he said, this is a good company, it grows at 12% per year, and it takes 8% of those, that 12% profit and reinvests it into the company through acquisitions or expansion or R&D.
Sorry, how did I freak that out? Yeah, so R&D and with the other 4%, they pay a dividend back to the shareholders. And he described this fictional company, he's like, it said, he said, it works fine, and the shareholders are happy, they get their 4%, the 8% of growth is still being reflected in the share price.
Everyone's happy. But then he said, what about a different way? What if they paid no dividend instead of keeping 8% and paying 4%? What if they kept the whole 12% when they do it, when the, when this company does it this way, that entire 12% growth, instead of 4% being bled off and cash to the investors, all 12% is being reflected in the share price because new investors who want to buy into this company know the value of the company.
They can see the value via the profit and via the book value and the acquisitions and all that. So it's all reflected in the company. And so the share price is going up. He also argues that he as Warren Buffett is better at making that 4% grow than you are. So instead of giving that cash back to you and letting you decide, do you wanna buy more stock, do you wanna spend it, do you want to put it in a bank account?
Whatever, if he keeps it, he can just basically do better with it than you can. He also said that if the company pays no dividend, then the shareholder basically gets to choose their own dividend. And so the way that you do that is just by selling a little bit of stock every year.
So 4% is kind of an arbitrary number. What if the investor wants 5% or 3% or 0% because they're still in the wealth building or wealth accumulation phase of their career? Then they don't have to take their 4% and decide what to do with it. They can take whatever they need, the 5% or the 0%.
And the last, and maybe the biggest point is the far bigger tax advantage. When you get a dividend, you have to pay taxes on that money as regular income that year. But if you have a, if it's in the growth of the company, you don't have to pay tax on that because until you sell it, and when you do pay tax on that, it's most likely going to be a long-term capital gains, which has a more advantageous tax situation for the individual, individual investor.
So Warren Buffett basically argues we don't pay dividends because I'm better at growing the money than you are. You can choose to get a dividend if you want, by selling a little bit of the stock every year. The remaining part of the company's gonna grow faster than your what you sell anyway.
So you're still going to have your, or have your stock go up in value, and you're going to get that big tax advantage. So that is why I don't chase dividends. That's why I don't seek out buying specific dividend stocks because I want to own a piece of Berkshire Hathaway and a piece of Amazon and Netflix and Google and all these other great growth companies.
One point of clarification is that I do own dividend stocks. I just don't own only dividend stocks. And in fact, I own all the stocks in an index fund. I'm a big fan of index funds. If you go to my Instagram account at Personal Finance Club, you'll see I talk about them all the time. They're a super low-cost way to diversify across an entire market.
So you can buy the entire US stock market at very low fee, and then you own every single dividend producing stocks. You get the dividends from all those stocks. So that's one thing that's cool about mutual funds and index funds is whenever those companies pay dividends, you still get them.
They're sent back to you in your account just like a dividend is, or you can reinvest it, but it also owns all the non-dividend stocks and it owns them in proportion to their size. So you don't have to decide which stocks are good, which stocks are bad, you just buy them all.
As Jack Bogle said,
You don't want to look for the needle in the haystack, you just buy the haystack.
That's kind of the concept behind an index fund. And then you own all the dividend and non-dividend producing stocks. So that's my rant on dividends.
Going to move to the Q&A section of today's episode. Today we have a question from across the pond from Kier from the UK. Let's hear what he has to say.
Kier: Why would I invest in the S&P 500 when I could invest in the top 10 to 50 of the S&P 500 and maybe get higher returns? My name's Kier from UK.
Jeremy Schneider: So Kier is asking, why would you invest in all 500 companies when you can just invest in the top 10 or 50? And so first I want to be clear what he means by top 10 or 50, when the S&P 500 is essentially a list of the 500 biggest companies in the US sorted by market cap, what market cap is the market capitalization, how big these companies are, if you add up all the value of all the stock.
And so I think he's asking, why am I buying all these little companies if I could just buy the 10, 10 biggest ones? And I think the reason he's asking that is because very recently, those top 10 biggest companies have done really, really well. They've outpaced, just like we talked about those faang companies, FAANG have done really, really well the last 10 years.
And they've also fared a little bit better than the small companies in this most recent coronavirus market crash. The big companies, you know, people are still going to Amazon and Google is still valuable, where the small companies are taking the hit a little bit more. And so he's asking why not own those big ones?
So the answer is they've done well recently, but maybe not historically. If you look back over the last hundred years, that's not always true. In fact, I think small-cap stocks slightly outpaced large-cap stocks over super long periods of time.
But what really matters isn't what did well the last five or 10 years. What you wanna know as an investor is what's going to do best the next five or 10 or 20 years. And if you want to know what's gonna do the best, right?
I'll tell you, I have no idea. I really don't. If I did know, I would be a much more wealthy man than I am. But what we do know is that you can't be sure of what's gonna do best. And so you want to just follow best investing practices.
And one of those rules is to not chase past performance, chasing past performances, any sort of looking backwards in deciding what to invest in based on that recent performance. And so when Kier is saying, Hey, why not just buy the top 10 because the next 10 years are likely not going to look like the last 10 years.
In fact, I'm afraid in five years, Kier's gonna send me another message saying, Hey, why would I buy all these big stodgy companies that have underperformed the last five years when I could just buy these exciting small companies that have done so well?
So that's a problem. When you chase past performance, you're basically buying high, what just did recently, well, the last few years, instead of buying everything and making sure that you guarantee your fair share of all market growth by buying the whole index fund.
So that's the show for today. If you want to read a very boring letter by Warren Buffett, you can see the link at youstaywealthy.com/76.
I have three more shows coming up in July. Taylor will be back in August. If you're enjoying the show, I'd love to hear your positive feedback on my Instagram at Personal Finance Club. And if you are not enjoying the show, please direct all complaints to firstname.lastname@example.org for his terrible choice of guest host.
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.