During the 20+ years I’ve been a financial advisor, I’ve noticed how often the market keeps playing the same devilish tricks, each time in a guise that differs just enough to fool us all over again.

Today’s “Stop Doing” post exposes one of these more common tricks of the trade: Investors who are seeking a reliable income stream for retirement should STOP building their investment strategy around dividend-paying stocks (or higher-interest-yielding bonds) in isolation, without considering them in the context of their total wealth management.

Speaking of devilish acts, let’s revisit The Wall Street Journal columnist Jason Zweig’s “The Devil’s Financial Dictionary” (emphasis is ours):

DIVIDEND YIELD, n. A company’s annual DIVIDEND divided by its current share price. “You buy a cow for its milk and a stock for its yield,” says an old Wall Street proverb. But when a company gets into financial trouble and has to cut its dividend to hoard cash for its own survival, the yield will shrink or disappear. Investors who buy a stock only for its yield may suddenly find themselves owning a cow that gives no milk and is too scrawny to butcher for the meat.

Clearly, I am not alone in my skepticism when I see investors investing in a stock because “it pays a good dividend.”

What is a Dividend?

Sweep away all the complexities about corporate profits, and you’re left with this truth: When a public corporation makes a profit, it has two choices on what to do with that cash:

1. Re-invest it back into the business, or
2. Return it to shareholders through cash dividends or share repurchase plans.

These concepts aren’t new. Nobel laureate Merton Miller and Franco Modigliani published a paper back in the 1960s, explaining why profits are profits, whether they’re “packaged” as dividends or share value. So, let’s take a look at why chasing dividend-paying stocks may not be all it’s cracked up to be. Continue Reading…