3 Reasons to Avoid Stocks That Pay Dividends | personal finance

(James Brunley)

Even if you don’t own one, it’s easy to see the appeal of dividend stocks: Any investment that puts cash in your pocket right now has its obvious upside, even if the dividend payouts aren’t huge. As the old cliché explains, a bird in the hand is better than a hundred in the wings.

But there are certainly some solid reasons why an investor might want to avoid dividend-paying stocks, if only for the time being. Here’s a rundown of three of the main reasons why they might not be of interest to him right now.

1. You need growth more than revenue right now

It’s easily the most obvious reason, but it should be pointed out nonetheless: There’s an opportunity cost in owning dividend stocks that you don’t actually need dividend payments from right now. That cost is the returns you will lose by not owning growth stocks that you could otherwise have invested in with that capital.

That’s not to say there isn’t potential for capital appreciation with a name that pays dividends. Take power from consumer goods Procter & Gamble (New York Stock Exchange: PG) as an example. P&G shares are nearly double their value just five years ago. That’s on top of the $15.25 in dividends distributed during that time, bringing the stock’s total return by about another tenth of its average price during this period. Not bad.

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Except, easy-to-purchase growth stocks Alphabet it nearly tripled in value during that same five-year period.

2. You don’t want to complicate (or raise) your taxes

Investors’ efforts to postpone and minimize taxes are understandable. But arguably they have become exaggerated. You have to pay taxes at some point, and you don’t want to hobble your general returns just to avoid a tax burden in the current tax year.

Image source: Getty Images.

On the other hand, if collecting dividends now, even if you’re reinvesting them in more shares of the same stock, is more of a tax hassle than it’s worth, it might be easier to avoid the headache altogether.

These scenarios are certainly few and far between. Examples might include a young person or couple who do not currently own dividend-paying stock outside of a tax-sheltered account, or a high-earning individual who already earns a large amount of dividend income. The former would be forced to collect and add information to a 1040 form for only a small amount of additional taxable income, while the latter may find that additional dividend income is taxed at a much higher rate than their current dividend income. . It’s enough to make you think twice.

3. You are prone to a false sense of security.

Finally, while more of a philosophical trap one falls into than a sudden rude awakening, dividend stocks risk making owners think they are safer and more stable than they really are.

Take PG&E (New York Stock Exchange: PCG) as an example. While the California-based utility is in the business that is seemingly best suited to supporting reliable dividend payments (selling electricity to consumers), the business itself is much more complicated than it appears on the surface. The company was found to be to blame for a spate of wildfires that ravaged California between 2018 and 2020, not only sending the stock up 80%, but forcing the company to indefinitely suspend the dividend that would otherwise be trustworthy, his actions had paid off and improved. since 2006.

Nobody saw it coming before it was too late.

Make it personal

None of this suggests that all dividend stocks should be avoided at all costs. There are good reasons to own them, and there are plenty of solid, dividend-paying names to choose from.

Rather, the point is that the dividend-paying portion of your portfolio should be just as diversified as the growth portion. And you should benefit from the same kind of regular checkups just to make sure that these seemingly stable companies are still as stable as when you first bought them.

In other words, you should only enter names that pay dividends if and when they work with a well-thought-out portfolio plan that can be adapted as situations change… theirs and yours.

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Suzanne Frey, an Alphabet executive, is a member of The Motley Fool’s board of directors. James Brumley has positions in Alphabet (A shares). The Motley Fool holds positions and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool has a disclosure policy.

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