The Dividend Dream Fallacy
(All opinions in this article are personal opinions, I highly recommend you do your own research into your retirement plans)
One of the first things a person comes to me with when they think about becoming financially independent is dividend stocks. After all, it’s easy to imagine a life where every few months your investment account adds in another few thousand dollars without you even having to do anything. Always completely automatic.
Dividends have an aura to them of easy, simple living: Imagine getting up to 9% of your investment every year with no risk, no buying and selling, and no worrying.
However, as we see with everything else in life, dreams too good to be true often are. Dividends are no exception and understanding why the company is giving the dividend is just as important as the percent yield you get back every year.
Take for example AT&T, a dividend investors favorite since it is a well-known, large company offering 7.68% dividends every year. Why not just park your savings in there and receive that easy, risk-free money, especially since on average the S&P500 only goes up 7–8% a year anyways?
First, think about why AT&T is offering such a high dividend. Dividends are meant to attract investors to invest in the company. Why would such a large company need to pay so much in dividends for upfront money? Because, after all, AT&T is losing business left and right and investors can see that.
Had you invested $100 in AT&T a year ago, you would have gotten back $7.60 from them, however, you would have lost almost $5 in the value of your investment, leaving you with a measly $2.60 at a time where a normal stock market investment would have netted you $28 (almost 14x as much).
The S&P 500 does not make 28% returns every year. However, a 2.6% return is still far below the average returns of the stock market, and would not be enough to retire on.
Many dividend stocks give high yields to hide the fact that they’re decreasing in value, so when looking at future stocks look past just the yield percentage and into the value and opportunities of the stock.
On the other hand, growth stocks like tech giants grow a lot, sometimes into the hundreds of percent, but also drop a lot quicker. They are not a safe investment by any means, but do have higher average returns.
In the middle are growth dividend stocks, like Coca-Cola or Costco, which give both dividends and growth (though not usually as much in dividends as dividend stocks and not as much growth as the risky tech stocks). Like often goes in finance, the happy solution is often in the middle. Growth dividend stocks have shown over and over that, if the dividends are reinvested, they often outperform the market.
The truth is that growth stocks are the best for growing wealth, dividend stocks are the best for maintaining wealth, and growth dividend stocks are somewhere in the middle. If you can’t afford to become financially independent and retire early right now, dividend stocks will never get you there. They are meant to keep your wealth, not grow it.
Invest in growth stocks to grow your wealth so you can become financially independent, then invest your retirement into the safer growth dividend stocks. With this strategy, your dreams may finally become true.
