Most equities pay qualified dividends, which are taxed at the long-term capital gains tax rate. And while investors can find ways to offset their gains when they sell stock, a dividend is taxed on the full amount of the distribution.
In taxable accounts, dividend strategies will cause unrealized capital gains to grow. Dividend growth stocks may dominate a portfolio over time. Advisors may find themselves spending more time reducing the amount of taxable investment cash flow generated by a client portfolio.
While dividend income has, thus far, been left untouched in the tax reform proposals making their way through the U.S. Congress, in the past dividends have been taxed at the individual income tax rate or higher, up to a rate of 90%.
Outro
Dividend investors have long held that they are the better allocators of capital, and that the success of dividend yield and growth strategies must mean that companies are less efficient at investing than shareholders.
On the other hand, several executives have proved themselves to be outstanding allocators of capital, none more prevalent than Berkshire Hathaway’s Warren Buffett. Berkshire Hathaway does not pay a dividend, but a $10,000 investment in 1964, when the company was founded, would have been worth more than $208 million by the end of June 2017.
Apple is a recent dividend payer, initiating its dividend in 2012. A dividend screening strategy would have missed investing in Apple during its dramatic run in the 2000s as it rode the success of the iPod, iPhone and iPad to become the world’s largest corporation in terms of market capitalization.
In the end, income-hungry investors might be better off investing in a way that is completely agnostic to income, especially in the current environment.
“It sounds intellectually appealing. All you have to do is get the yield and don’t worry about it,” says Altfest. “At this point in the cycle, when yields in a broad sense are the lowest they’ve ever been, it doesn’t make sense to concentrate in these stocks or attempt to run this kind of strategy. If someone wants to do it, wait until the market corrects. If the economy continues picking up steam, inflation is going to pick up and bond yields will tick up faster. Each time the Federal Reserve acts, it’s going to hurt the yield vehicles.”