“After a meal there’s nothing like a good cigar”

– Blondie from The Good, the Bad and the Ugly – Wikiquote

Ok, so that quote has nothing to do with investing, but you can just picture Eastwood saying it.  Like everything in life, there are good things, bad things, and ugly things.  The same can be said about dividend investing and dividend in general.  Here is how dividends break down when I thought of them as the good, the bad, and the ugly.[ad#tdg-embedded]

The Good:

Dividends provide additional capital to invest in more stocks.

When dividends give off income to the investor, it allows the investor to reinvest that capital into more shares of the same company or shares of another company or asset.  Over time this can compound your returns dramatically.

Dividend stocks have produced a higher return with less risk.

The top-quintile of high dividend stocks has been proven to produce a higher return with less risk than the stocks in the lower quartiles.  The following chart from Lehman Brothers drives this point home.

The Bad:

Dividends are not as tax efficient as stock buy-backs.

Getting dividends has tax implications for the investor.  If these dividends are in a tax protected account then this is not a worry.  However, if they are in a taxable account then the investor needs to be cognizant of these taxes and ensure that they are planned for appropriately.

Cash paid out as dividends cannot be reinvested back into the business.

For the company paying out dividends, there is less money available to reinvest back into the business for future growth.  This can be an issue as investors like to see sales and earnings growth over time and that often requires additional capital.  If dividends are paid then that money is no longer available for those opportunities to enhance growth.

The Ugly:

When dividends are cut the stock price tanks.

Dividends do get cut.  Just look back at Bank of America (BAC) who had paid a growing dividend for years and years.  Then all of a sudden it had to cut its dividend to survive.  This had a very dramatic effect on my investors, including those retirees who relies on BAC to fund their retirement cash flow.  Dividends are never guaranteed!

Dividends can lure you into a false sense of protection.

I have found that dividends provide an investor with a sense of security that may not be warranted.  Just because the company pays a dividend does not mean it is a good stock.  And just because you are receiving income from that stock does not mean you need to never sell it.  You still need to critically analyse that investment to ensure it fits into your portfolio.

Dividends Still Win

Even considering the bad and ugly aspects of dividend investing, there is one aspect of dividend investing that trumps them all.

Historically, dividends have made up the majority of the overall stock market’s gain. Take a look at the image below.  You can see that over time, 64% of the overall return of the stock market has been made up from dividends.  That is in no way insignificant and cannot be ignored.  Dividends are very important and should not be ignored.

• Alternative Investments
• Year-to-Date Portfolio Performance
• Best Dividend Investing Posts of the Week – October 3, 2009
• The Four Important Dates for a Dividend Investor
• Day 2: The Dividend Key – Real Return Comes from Dividends