Q&A: Should I Shift Money to Dividend-Producing Stocks?

Q&A: Should I Shift Money to Dividend-Producing Stocks?

Question: Our financial advisor tells us he wants to shift more of the money in our investment accounts into dividend-producing stocks and away from growth stocks. He explained that returns from each have been about equal historically, but that he now believes that dividend stocks are going to start producing greater returns than growth stocks. I hadn’t heard anything about that, but he’s our advisor and an expert in this area, so I suppose I should trust him. However, I’d like your opinion too. Does this approach make sense?

Ric: I’m not going to say that it doesn’t make sense, but I am concerned about the bet he wants to make.

There are two ways investments can make money. They might generate income (like a bond or a savings account) or they might grow in value (like a rare painting). Some can do both: Stocks can pay a dividend and grow in value; real estate can produce rental income and grow in value.

Many people believe that most of the profits from the stock market come from growth. In fact, about half the profit has historically come from dividends, as your advisor pointed out.

Trying to make money by investing in something that grows but doesn’t produce income is riskier than investing in something that can profit both ways. But we must recognize that the more income a stock generates, the less likely it is to grow in value. Your advisor seems to think that dividend-paying stocks will be more profitable than growth stocks (those that don’t pay dividends), so he’s saying you should shift more of your money to those kinds of stocks.

I’m not going to say that he’s wrong. I will just say that I don’t know whether he’s right. In fact, nobody does. So to overweight your portfolio with dividend-paying stocks is a big bet. And he could be wrong.

First, stocks might rise more than he’s predicting, causing you to miss some of that profit potential.

Second, he’s assuming dividend stocks will make money. But if stock prices don’t rise much (the basis of his recommendation), that could mean there’s going to be an overall sluggishness in the U.S. economy. If that should occur, corporate profits could fall — and they can’t pay dividends if they don’t have sufficient profits. This could cause companies to reduce or eliminate their dividends. If they do that, not only will you miss out on the dividends you expected, but you also could experience a decline in the value of those stocks. (The prices of dividend-paying stocks often are based on the dividends themselves: If the dividends drop, investor interest drops, and prices of those stocks naturally fall.) Thus, being wrong could be very costly.

So, like I said, the advice is more of a bet, and I’m not a big fan of making bets with my life’s savings. You shouldn’t be either.

Instead, we advise a more diversified approach. Of course, such a portfolio would contain dividend-paying stocks, but we wouldn’t overweight our portfolio with them. And we wouldn’t suddenly increase our weighting simply because someone believes they’ll start to do well. There are half a million investment advisors in this country, plus thousands of security analysts and money managers. Are you sure that your advisor is “the one” out of all of them who knows better than everyone else?

Originally published in Inside Personal Finance October 2016

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