Busting 5 Biggest Myths About Dividend Investing

Investors are always on the lookout for low-risk, high-reward investment strategies, and a popular choice is dividend investing. Dividend investing involves investing in stocks and funds that pay dividends to investors offering them a regular source of income.

Dividend investing is often touted as the safest stock market investment offering high returns. However, we must recognise that no investment strategy is 100% flawless.

To make informed financial choices, objectively identifying the positives and negatives of dividend investing is crucial. In this blog, we help you do so by busting some of the biggest myths associated with dividend investing.

Myth #1: Dividend Investing is Boring

Reality: Dividend stocks are often associated with slow-growing companies, which gives birth to the notion that dividend investing is boring. However, this is true only if you look at high-yield stocks. Low-yield stocks offer the excitement of investing in stocks with considerable future growth potential. They also provide you with the benefit of higher payouts in the long run.

Myth #2: Dividend Investing is Tax Efficient

Reality: This myth arises from the perception that dividend payouts are taxed lower than other investment options. While it is partially true that dividend payouts are taxed at a lower rate, the complete truth is that they are taxed at the same rate as long-term capital gains.

This means that dividend investing is tax efficient only compared to other investment options such as bonds. However, the tax efficiency provided by non-dividend stocks is not too far behind.

Additionally, dividend stocks generate lower total returns than non-dividend stocks. As a result, the net income generated is not significantly higher and can sometimes be lower than that from non-dividend investing.

Myth #3: High-Yield Stocks are the Best

Reality: While most investors find high-yield stocks attractive, there might be better options. Here’s why.

Dividend payouts are taken out of the company’s cash flow. This means that the higher the payout, the less cash the company has in hand to spend on growth and expansion. A higher yield is always at the cost of lower cash flow.

When a stock offers high yields, a lower percentage of profits is reinvested into the business. This could indicate that the company’s management does not prioritise reinvesting into it as they do not see significant growth potential.

Myth #4: Dividend Investing is the Safest Choice

Reality: Dividend investing is indeed a relatively safe and reliable choice. Several companies have been exceptionally consistent in dividend payouts over the last 25 years. However, painting all dividend investment options as entirely safe is not wise.

Regular dividend payouts can be considered as an indicator of the company’s financial health. However, it says nothing about whether the company can maintain this consistency in the future.

It is important to remember that the market is volatile. Any financial instrument that operates within a stock market carries some risks. An excellent example of this is the case of General Electrics. In 2009, for the first time in 70 years, the company reduced its quarterly dividends from $0.31 per share to about $.10 due to the recession.

Second, there have been instances where dividends have been artificially pushed up, and companies have had to borrow from banks to pay their investors. This makes investing in weak businesses a hidden risk you must consider before buying a dividend stock.

Myth #5: Dividend Investing Offers Good Diversification

Reality: Most new investors start their journey in the stock market by investing in dividend stocks as they add considerable variety to their portfolio and are relatively low risk.

Though this might be a good start, remember that if you invest only in dividend stocks, you miss on all the non-dividend stock options. By focusing only on dividend investing and ignoring non-dividend stocks, you pass up on equally great and sometimes better opportunities to diversify your portfolio further.

Final Thoughts

While dividend investing is an excellent source of passive income, it is wise to be mindful of its associated risks. Understanding the myths surrounding dividend investing and replacing those myths with reality is essential to making intelligent investment choices.

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