This one is just begging for me to respond! I appreciate the viewpoint here.
I don't particularly agree with your viewpoint of not focusing on dividends just because you don't need to file with the IRS every year. Keep in mind that I am Canadian and don't know your tax system, but I would not use that excuse to make any investment decision.
I think your overall premise is not to limit your investment horizon, which I am ok with. I just think that this reason you give does not make sense to me.
Google thought provoking piece!
I meant 'good' thought provoking piece!
The Dividend Guy,
It is really a quick math:
1) Assuming you invest $10,000 on an investment that always yields 10% annually, and you continue to reinvest dividend after being taxed 20% on the dividend, after 10 years, you will have:
$10,000 * (1 + 10% - 2%) ^ 10 = $21,589
2) For a similar investment that appreciates 10% every year but don't pay out dividends, after 10 years your investment will be worth:
$10,000 * (1 + 10%) ^ 10 = $25,937
And if you sell it and get taxed on your capital gain at a rate of 20%, you can keep:
$25,937 - ($25,937 - $10,000) * 20% = $22,750.
That's a difference of $1,161!
MM, I totally agree with you on paper. Mathematically speaking it is more efficient for the company to retain the earning and reinvested them as double taxation is avoided.
But what is good on paper is not always best for your wallet. I like to think of it this way - If a company never pays a dividend how are you going to get any return on your investment? The only way you can get a return is to SELL your investment. Being a value investor yourself you know that puts you in a potentially untimely situation if you need to develop cash flow off your investment. Your 10% annual return might only be worth 5% to mr. market at that time.
How about if you automatically reinvest the dividends, do you still have to pay tax on the dividends then?
VMD, yes, you still need to pay tax on dividends even if you automatially reinvest.
2million, your point is valid only if you are trying to live off of your investments.
Most people though are trying to grow their investments, and dividends are a not the best way to grow your investments, since they are taxed and not necessarily in the shareholders' best interest, just as MM wrote about.
MM thank you for you article suggestions, I am actually an undergraduate student, and I always try to find information of this type put in a very straight forward manner.
MM, your basic assumption appears to be that the companies that invest the money in themselves will do so in such a way that they continue to operate as efficiently as do the companies paying dividends. I disagree with your basic assumption. Companies paying dividends are less likely to take foolish risks knowing that they still need to meet their dividend obligations to shareholders.
As I recall, during the tech bubble, a lot of the tech companies frowned upon dividend payouts and instead invested accumulated cash back via stock re-purchases. Ironically, the overall number of shares outstanding rarely decreased because the incredible amount of stock options that had been granted substantially increased the number of shares outstanding. Those companies had to repurchase all of those shares just to maintain the same number of overall shares. In my opinion, that was a waste of shareholder value. If those companies had been paying decent dividends at that time, they would have faced a shareholder revolt over the shareholder dilution caused by the stock option grants.
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