Many investors and financial advisors focus on dividend-paying companies. At first glance, it sounds appealing. You receive regular income, no matter what the market does. But when you take a closer look, dividends may not be as valuable as they seem.
Dividends do not actually increase your investment’s value.
This may be surprising if you have heard the comparison between dividends and rental income. The idea is that you get paid just for holding the investment. But that comparison breaks down quickly when we look at how dividends actually work.
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What Is a Dividend?
A dividend is a payment from a company to its shareholders. These payments are usually made in cash and often come quarterly. The goal is to provide consistent income, even if the company’s stock price does not increase.
It sounds similar to owning a rental property. You get rent even if your house does not rise in value. But here is the key difference.
When a company pays a dividend, the company’s value goes down by the amount of that dividend. No new value is created. It is simply a transfer of money.
A Simple Example
Imagine a company is worth one million dollars. It decides to pay out fifty thousand dollars in dividends. Now, the company is worth nine hundred and fifty thousand dollars.
If you own ten percent of that company, your share is worth one hundred thousand dollars before the dividend. After the dividend is paid, your shares are worth ninety-five thousand dollars, and you have received five thousand dollars in cash. The total value is still one hundred thousand dollars.
The dividend did not create any extra value. It just moved money from the company into your hands.
Why the Rental Property Comparison Fails
If you own a rental property worth one hundred thousand dollars and receive five thousand dollars in rent, you are now worth one hundred and five thousand dollars. Rent adds value. Dividends do not.
This is the critical difference. Dividends feel like income, but they are not extra income in the same way that rent is. You are not growing your wealth. You are simply moving it.
A Tax Perspective
Some investors prefer dividends because they provide income in retirement. But that income may come with more tax than necessary.
If you hold dividend-paying stocks in a non-registered account, the dividends are taxed. If you hold non-dividend stocks and sell shares when you need money, you may pay less tax. Capital gains are taxed more efficiently than dividend income.
You also get more control. If you need three thousand dollars, you can sell that exact amount of shares. If you get a five thousand dollar dividend, you may pay tax on money you do not even need.
Inside registered accounts like TFSAs or RRSPs, tax does not affect this decision. But outside of them, it can make a meaningful difference.
Final Thoughts
There is nothing wrong with owning dividend-paying stocks. Many strong companies offer dividends. But it is important to understand that dividends do not increase your wealth. They only move money from inside the company into your personal account.
The next time someone promotes a dividend strategy as a way to grow your wealth, pause for a moment. Make sure the recommendation aligns with your goals, your tax situation, and the full picture of your retirement plan.
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