It’s clear why dividend-paying companies might be appealing to investors. After all, who doesn’t want the opportunity to sit back and receive a constant supply of money?
While dividends can be a wonderful source of passive income, they aren’t always an excellent investment. Here’s why it’s essential to exercise caution with dividend stocks – or perhaps avoid them entirely.
1. They may not align with your investing strategy
Companies that pay dividends to shareholders decide to distribute their earnings rather than invest more money in the company. And this isn’t always a positive thing. Dividend-paying firms may stifle their own development by distributing funds instead of reinvesting them. Furthermore, share price appreciation might be slower as a result of this practice.
Dividend stocks may not be the best fit for your investing plan if it focuses on building up a portfolio of growing firms. And there’s no sense in deviating from your approach just because things are going well thus far.
2. They can increase your tax bill
If you invest in dividend-paying equities through a tax-advantaged retirement program like a 401(k) or IRA, the dividends you receive on an ongoing basis will not be taxed. However, if you own dividend stocks in a brokerage account, those payments may result in a higher tax burden for you.
Although it’s true that dividends are taxed at a lower rate than ordinary income, the effect may not be as severe. However, taxes are taxes in the end, and if you don’t want to pay the IRS more each year, you may wish to avoid dividend-paying stocks.
3. They can lead you to make poor investment choices
It’s simple to get caught up in the allure of a high dividend. But you could be lured into putting your money into firms that aren’t really viable.
It’s a common misconception that corporations offering large dividends can afford to do so, and as a result, they’re clearly doing well. That’s comparable to claiming that the guy in your neighborhood who drives a $90,000 sports vehicle must be rich because he can afford those automobile payments. In reality, that guy might be drowning in debt or have no money saved, and his expensive vehicle is simply hiding it.
In the case of dividend stocks, this is also true. Companies that pay significant dividends may not be doing well financially. If you don’t make the distinction, you could become dissatisfied with the stocks you invest in.