The Dark Side of Dividends

Stock Boosters Won’t Mention the Dark Side of Dividend Stocks

Bullion.Directory precious metals analysis 05 January, 2022
By Peter Reagan
Financial Market Strategist at Birch Gold Group

This year is already off to a roaring start, as easily spooked Wall Street investors are “bracing for” the Fed’s first rate hike in three years. Of course, that’s just one piece of the uncertainty puzzle as 2022 starts to take shape.

High inflation, no longer merely “transitory,” is expected to linger for a while. The U.S. national debt is at $29.6 trillion, and near-zero interest rates guarantee after-inflation losses on virtually everything from savings accounts to junk bonds. The stock market’s either historically overvalued or clearly in a bubble…

This situation leaves those of us saving for retirement scrambling for investments that can provide some stability during chaotic times. One option we hear promoted quite a bit among stock boosters: dividend stocks.

These are primarily large, established “blue chip” companies that have a track record of paying shareholders on a quarterly or annual basis. For example, USA Today recently offered 3 reasons we should consider dividend stocks for our savings:

1. Potential income. Dividends “generate regular income streams, but they still experience market volatility. Some companies decide to take their profits and distribute those to shareholders. These are usually mature, stable companies with limited growth potential.”
2. Tax treatment. “Investment returns in a Roth are distributed tax-free prior to age 59 and a half are also tax-deferred within traditional IRAs and 401(k) accounts. However, when you take distributions from those accounts, they will eventually be taxed as ordinary income.”
3. Dividends are somewhat stable. “Dividend stocks are a great source of growth, but they also offer more stability than the market in general.” (We’ll get to this last part in just a minute).

Taken at face value, this sounds like a great idea, doesn’t it? But there are some inconvenient details retirement savers must understand to make an educated choice…

The dark side of dividends

There are at least three reasons to be cautious about putting your hard-earned retirement dollars into dividend stocks. They aren’t things your financial advisor, broker or stock-boosting mainstream media publication are likely to point out.

Here they are, presented in no particular order:

1. How do you figure out which dividends produce “reliable” returns?

Dividend stocks might look good on paper, but they still fluctuate with the stock market. Even worse, they tend to go up when the market goes up (when you don’t need them to). Conversely, they tend go down when the market goes down (when you don’t want them to).

The return on investment they deliver needs to exceed inflation, on average. And that’s where experts who favor dividends lean on statistics to make their case. That said…

2. Long time frames and averages only reveal part of the story

As Compound’s Charlie Bilello said,

By changing the start and end date, you can win just about any argument over what’s the best investment.

That sounds like a joke (maybe it is) but it’s also true.

For example, David Van Knapp revealed a “sleight of hand” that can be used to make dividends look better than they are.

At first, dividends appear to be the best investment since Microsoft-in-2008:

There is no question that over very long time frames, dividend growth has handily exceeded inflation. Year-by-year, dividend growth was higher than inflation in 31 of 51 years. The average yearly rate of dividend growth (5.4%) exceeded the average annual inflation rate (4.1%) by 32%. [emphasis added]

The problem is, anyone who is saving for retirement now doesn’t get the benefit of returns that happened 30 years ago.

Van Knapp explains that there were only 12 years in the last 51 in which dividend growth eclipsed the latest official inflation rate of 6.8%. That inflation (which could rise even higher) is the number that retirement savers care about today.

In addition, there’s the risk that any stock could simply stop paying dividends altogether.

3. Companies that pay dividends aren’t immune to black swans

Dividends are not a guaranteed investment. Any single company that pays dividends can go bankrupt, and they have in the past. Remember Indymac, or Lehman Brothers, or Bear Stearns, Merrill Lynch, Washington Mutual, Global Crossing or Enron?

Any company can suffer a catastrophe, like BP’s Deepwater Horizon oil spill or Exxon’s Valdez disaster. A concentrated position in any single stock, no matter how great its fundamentals and solid its dividend track record, may end in tears.

The big takeaway here? Prudent investors pay attention to both the pros and cons of their investments. They don’t put all their eggs into one basket. And they educate themselves about a variety of asset classes when preparing their retirement strategies.

Looking great on paper might not be enough

For some people, dividend stocks may in fact be worth a closer look (along with other inflation-resistant investments compared). We’re not taking sides here, merely pointing out the facts that seem to elude stock-boosters.

Like many other investments, dividend stocks that look good on paper are likely to suffer from stock market volatility. They’re a riskier choice than stock bulls admit when the market is volatile or overvalued (like it is now). Especially with inflation on the rise.

So if you’re looking to add stability to your retirement savings, you owe it to yourself to have all the facts. And if you’re looking for a “safe haven” for your savings, consider tangible assets like physical gold and silver. Their track record during volatile markets may be exactly what you need to counter higher-risk investments.

This article was originally published here

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