Skip to main content
Home Working together to build your tomorrow

Over the past several years, I been sympathizing with folks who are feeling a little queasy about the stock market's ability to set new records for sustained increases in value. "When will the next shoe drop?" is the question in the minds of many investors -- including me. The antidote for anxiety is certainly not to bail out into cash. Anyone could have made the argument for adopting that course in January 2011 -- 22 months after the market bottom in March 2009. That was the point at which someone who stayed the course would have recovered the loss since 2007 and decided that it was time to take chips off the table.

Since that time, however, the buy-and-hold investor has more than doubled what they had in January 2011, so selling back then would have created a substantial lost-opportunity cost.

I have encouraged investors instead to consider stocks that pay dividends -- both as investments to provide income in retirement but also to bolster the values of stock holdings leading up to retirement. There is, however, a yin and yang to all investment strategies.

Dividends are very expensive for companies to pay out. The irony of paying dividends over long periods of time is that almost all dividend payers also have long-term debt. If they hadn't paid all those dividends, they would have been able to pay down their debt and would be debt free. For example, over almost 40 years ending in the mid '90s, companies borrowed $2 trillion while paying out dividends of $1.8 trillion. They effectively borrowed what they paid out.

Companies also have to pay taxes on profits before paying out dividends. The same money reinvested in a company's growth would have been largely tax deductible considering that the biggest expense of growth is the cost of human capital -- salaries and benefits.

Warren Buffett (him again) has always adopted a different posture. He has never paid dividends because he feels that people invest in his company because they want him to manage their money. If they think they need to spend some money or invest elsewhere, they can just sell some of their stock. It's crazy, in his mind, for companies to pay dividends instead of just reinvesting their profits.

So why are dividends so attractive to us when we would be better off in the long run just leaving profits in the companies whose shares we own?

The answer lies in our genetic code. We are wired to feel worse about losing money than by enjoying the gain that comes from making a comparable amount of profit. Spending just our profits and never invading more than the profit portion of our capital takes discipline, which most of us have in limited quantities. Companies that pay dividends impose the discipline for us -- like joining the Marine Corps. We just spend those dividends that are parceled out and never touch the principal. Like Oliver Twist told "no" when he asks for more.

The unintended consequence of dividend inefficiencies is that there are a lot of people who like the positive message and automatic pilot and discipline of steady dividends. Because of this, dividend-paying stocks are popular during uneasy times and this increases their value in the minds of investors. As inefficient as dividends may be, their popularity tends to support the stock prices of companies that pay them. This is especially true when a falling stock market's value becomes disconnected from the intrinsic company values that stocks normally reflect.