by Investor Advocate Partners
It is a similar story for investors in North America, Australasia and most of Europe. Investors in southern Europe, most of Asia and Central America are paying even higher charges.
Investors often see dividends as a way to generate income. But dividend strategies are not the only way to produce cash, and investors should be aware of the potential tradeoffs that accompany a focus on dividends.
For stockholders who own dividend-paying shares, those payments arrive on a schedule (quarterly, in many cases). The cash to fund a dividend must come from somewhere, however. We know the price of a stock is potentially influenced by all expected future cash flows to shareholders. If cash is paid today in the form of a dividend, the stock price—and total market capitalization—of the issuing company may therefore fall, as the hypothetical Portfolio A in Exhibit 1 shows. That means, all else being equal, an investor who receives a dividend may also be left with a less valuable equity holding.
Pay, Your Way
Comparing methods of income generation
For illustrative purposes only. Assumes the stock price will fall by roughly the amount of the dividend and assumes no nondividend-related price movement.
An alternative method of raising cash is to simply sell shares. Exhibit 1 compares the two methods of generating income by contrasting Portfolio A with the similarly valued hypothetical Portfolio B. While Portfolio A receives income through a dividend payout, Portfolio B generates it through a stock sale.
The investor in Portfolio A, in which a dividend is issued, ends up holding the same number of shares as were held prior to the dividend payout, but we assume that those shares have declined in value. The investor in Portfolio B holds a reduced number of shares that haven’t seen their value decrease as a result of a dividend payout. The two approaches arrive at the same place—both investors end up with $100 in cash and $1,900 in stock, notwithstanding potential trading costs or tax implications. But there are potential downsides to the dividend approach when contrasted with the stock-sale approach.
First, the average proportion of firms paying dividends in the US was about 52% from 1963 through 2019,1 meaning an investor focusing only on those stocks is missing out on nearly half of investible US companies. A second consideration is that a dividend’s value, while not subject to the same degree of fluctuation as a stock price, isn’t guaranteed. Just 10 years ago, more than half of dividend-paying firms cut or eliminated those payouts following the financial crisis.2 More recently, a company that had consistently paid dividends for more than a century, General Electric, slashed its payout to just one cent a share,3 and the UK’s Vodafone Group cut its full‑year dividend for the first time in two decades.4 Thirdly, investors may give up flexibility in terms of the timing and the size of the payout when they rely on company-issued dividends. With stock sales, an investor determines the amount and schedule of the income.
When considering an investment, it is also important to assess total return, which accounts for capital appreciation (or loss) alongside dividend income. High dividend yields may not lead to high total returns. Exhibit 2 plots the trailing 12-month returns of S&P 500 Index constituents as of December 31, 2019, with each dot representing a company. It’s clear that companies with greater dividend yields, the dots located higher up the vertical axis, weren’t consistently those with a higher total return over that period.
Dividend yields and 12-month returns for S&P 500 firms as of December 31, 2019
Note: Plotted yield of 18.38% reflects a stock that paid special dividends. Source: Dimensional calculations using Bloomberg data. For constituents with reported returns of less than one year, returns shown since earliest date available. S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Dividend yield is calculated as the sum of dividends paid in calendar year t divided by end of year t-1 price.
Income generation may be a priority for some investors, but other important investment considerations, such as diversification and flexibility, needn’t fall victim to that aim. While the use of stock sales instead of dividends to create cash flow may involve trading costs and tax considerations, those concerns may be offset by the benefits of investing in companies that don’t currently pay dividends. An approach focused on income derived through dividends may not be the most desirable choice when weighing broader investment goals.
1Source: Dimensional, using data from CRSP. Stocks are sorted at the end of each June based on whether a dividend was issued in the preceding 12 months.
2Stanley Black, “Global Dividend-Paying Stocks: A Recent History” (white paper, Dimensional Fund Advisors, March 2013).
3Janet Babin, “GE cuts dividend to a penny per share. Why bother keeping it at all?” Marketplace, American Public Media, October 30, 2018.
4Adrià Calatayud, “Vodafone cuts dividend after swinging to 2019 loss.” MarketWatch, May 14, 2019.
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision.
Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Investing risks include loss of principal and fluctuating value.
All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.
Many individuals may not know why paper money is issued by the Federal Reserve and what role the Federal Reserve plays in the economy. Here’s an inside look.
Have you ever taken a close look at paper money? Each U.S. bill has the words “Federal Reserve Note” imprinted across the top.1 But many individuals may not know why the bill is issued by the Federal Reserve and what role the Federal Reserve plays in the economy. Here’s an inside look.
Tip: Checks. Due to the onslaught of electronic check collection, the Federal Reserve now processes paper checks at just one location nationwide, down from 45 locations in 2003. Source: Board of Governors of the Federal Reserve System, 2016
The Federal Reserve, often referred to as the Fed, is the country’s central bank. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system.2 Prior to its creation, the U.S. economy was plagued by frequent episodes of panic, bank failures, and limited credit.
The Fed has four main roles in the U.S. economy.3
In addition to its other duties, the Fed has been given three mandates with the economy: maintain maximum employment, maintain stable price levels, and maintain moderate long-term interest rates.4
Fast Fact: Unwieldy Patchwork. In the early 1800s, the U.S. had no central bank and no common currency. The monetary system ran through a patchwork of state-chartered banks with no federal regulation. By 1860, there were nearly 8,000 of these banks, each issuing its own banknotes. Source: Federal Reserve Bank of San Francisco, 2018
It’s important to remember that “the Fed” cannot directly control employment, inflation, or long-term interest rates. Rather, it uses a number of tools at its disposal to influence the availability and cost of money and credit. This, in turn, influences the willingness of consumers and businesses to spend money on goods and services.
For example, if the Fed maneuvers short-term interest rates lower, borrowing money becomes less expensive and people may be motivated to spend. Consumer spending may stimulate economic growth, which may cause companies to produce more product and potentially increase employment. When short-term rates are low, the Fed closely monitors economic activity to watch for signs of rising prices.
On the other hand, if the Fed pushes short-term rates higher, borrowing money becomes more expensive and people may be less motivated to spend. This may, in turn, slow economic growth and cause companies to decrease employment. When short-term rates are high, the Fed must watch for signs of a decline in overall price levels.
Supervise and Regulate
The Fed establishes and enforces the regulations banks, savings and loans, and credit unions must follow. It works with other federal and state agencies to ensure these financial institutions are financially sound and consumers are receiving fair and equitable treatment. When an organization is found to have problems, the Fed uses its authority to have the organization correct the problems.
The Fed maintains the stability of the financial system by providing payment services. In times of financial strain, the Fed is authorized to step in as a lender of last resort, providing liquidity to an individual bank or the entire banking system. For example, the Fed may step in and offer to buy the government bonds owned by a particular bank. By so doing, the Fed provides the bank with money that it can use for its own purposes.
Banker for Banks, U.S. Government
The Fed provides financial services to banks and other depository institutions and to the U.S. government. For banks, savings and loans, and credit unions, it maintains accounts and provides various payment services, including collecting checks, electronically transferring funds, distributing new money, and receiving and destroying old, worn-out money. For the federal government, the Fed pays Treasury checks; processes electronic payments; and issues, transfers, and redeems U.S. government securities.
Each day, the Fed is behind the scenes supporting the economy and providing services to the U.S. financial system. And while the Fed’s duties are many and varied, its focus is to maintain confidence in banking institutions.
A De-Centralized Central Bank
The Federal Reserve System consists of 12 independent banks that operate under the supervision of a federally appointed Board of Governors in Washington, D.C. Each of these banks works within a specific district, as shown.
Source: Federal Reserve Board of Governors, 2018
1. U.S. Bureau of Engraving and Printing, 2018
2, 4. Federal Reserve Bank of San Francisco, 2018
3. Board of Governors of the Federal Reserve System, 2016
For many people, retirement income may come from a variety of sources. Here’s a quick review of the six main sources:
Social Security is the government-administered retirement income program. Workers become eligible after paying Social Security taxes for 10 years. Benefits are based on each worker’s 35 highest earning years. If there are fewer than 35 years of earnings, non-earning years are averaged in as zero. In 2019, the average monthly benefit was estimated at $1,461.1
Personal Savings and Investments
Personal savings and investments outside of retirement plans can provide income during retirement. Retirees tend to go for investments that offer monthly guaranteed income over potential returns.2
Individual Retirement Accounts
Traditional IRAs have been around since 1974. Contributions you make to a traditional IRA may be fully or partially deductible, depending on your individual circumstances. Distributions from a traditional IRA are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions.
Roth IRAs were created in 1997. Roth IRA contributions cannot be made by taxpayers with high incomes. To qualify for the tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½. Tax-free and penalty-free withdrawals also can be taken under certain other circumstances, such as a result of the owner’s death. The original Roth IRA owner is not required to take minimum annual withdrawals.
Defined Contribution Plans
Many workers are eligible to participate in a defined-contribution plan such as a 401(k), 403(b), or 457 plan. Eligible workers can set aside a portion of their pre-tax income into an account, which then accumulates, tax deferred.
Distributions from defined contribution plans are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions.
Defined Benefit Plans
Defined benefit plans are “traditional” pensions—employer–sponsored plans under which benefits, rather than contributions, are defined. Benefits are normally based on factors such as salary history and duration of employment. The number of traditional pension plans has dropped dramatically during the past 30 years.
In a recent survey, 68% of workers stated that they planned to keep working in retirement. In contrast, only 26% of retirees reported that continued employment was a major or minor source of retirement income.3
Expected Vs. Actual Sources of Income in Retirement
What workers anticipate in terms of retirement income sources may differ considerably from what retirees actually experience.
Employee Benefit Research Institute, 2019 Retirement Confidence Survey
- Social Security Administration, 2019
- Insured Retirement Institute, April 2018
- Employee Benefits Research Institute, 2018