Why Income Investing Will Not Give You Income | Common Sense Investing

TL;DR

Income investing may not provide the desired income as dividend payments decrease the stock value and result in reduced diversification and missed opportunities.

Transcript

In my last two videos I talked about high yield bonds and preferred shares. These are two alternative asset classes that investors venture into when they are seeking higher income yields. I told you why you might want to avoid those asset classes. Today I want to tell you why focusing on investing to generate income is a flawed strategy altogether,... Read More

Key Insights

• 🧑‍🏭 Dividend-paying stocks are not inherently better investments than non-dividend-paying stocks, as dividends are not among the factors that explain stock returns.
• 🥺 Relying solely on income investing leads to reduced diversification and missed opportunities in the market.
• 💄 Dividend payments decrease the value of stocks, making the dividend-focused approach less reliable for generating income.
• ↩️ A total-return approach, investing in a globally diversified portfolio of total market index funds, offers greater tax efficiency, better diversification, and captures market returns.
• 👲 Small cap stocks, which are often excluded in income-focused strategies, can provide significant returns and diversification.
• 🎮 Dividend investing is important for income but should not be the sole focus of a portfolio.
• 🥺 Income investing is a popular lifestyle choice, but it may not necessarily lead to higher income in the long run.

Questions & Answers

Q: Why do people prefer dividend-paying stocks?

Some potential explanations are poor self-control (limiting spending to only income), loss aversion (uncomfortable selling shares to generate income), and the perception of dividends as "free money."

Q: Do dividends impact the value of a stock?

Yes, the payment of a dividend decreases the value of the stock. The investor's overall position remains the same regardless of whether the company pays a dividend or not.

Q: Are dividend-paying stocks better for taxable investors?

On an after-tax basis, investors without dividends are in a better position as they can choose to defer their tax liability by not selling any shares. Dividend investors pay tax on their dividends, regardless of whether they spend them or not.

Q: Does dividend investing reduce diversification?

Yes, as about 60% of US stocks and 40% of international stocks do not pay dividends. By focusing only on dividend-paying stocks, investors limit their diversification and miss out on opportunities in non-dividend-paying companies and sectors.

Summary & Key Takeaways

• Income investing involves building a portfolio of dividend-paying stocks and bonds to generate sufficient income for maintaining a desired lifestyle.

• Dividend-paying stocks are not inherently better investments than non-dividend-paying stocks, as they are not among the factors that explain stock returns.

• Dividend payments decrease the value of the stock, and relying solely on dividend-focused portfolios leads to tax inefficiency, poor diversification, and the exclusion of important parts of the market.