3 Reasons to Avoid Dividend-Paying Stocks | personal-finance

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(James Brunley)

Even if you don’t own any yourself, it’s easy to see the appeal of dividend stocks — any investment that puts cash in your pocket right now has its obvious upside, even if those dividend payments aren’t enormous. As the old cliche explains, a bird in the hand is worth two in the bush.

But there are certainly some sound reasons an investor might want to make a point of steering clear of dividend-paying stocks, even if only for the time being. Here’s a rundown of three of the top reasons they may not be in your best interest right now.

1. You need growth more than income right now

It’s easily the most obvious reason, but needs to be stated all the same: There’s an opportunity cost in owning dividend stocks that you don’t actually need dividend payments from right now. That cost is the returns you’ll be missing out on by not owning growth stocks you could have otherwise invested in with that capital.

That’s not to suggest there’s no capital appreciation potential with a dividend-paying name. Take consumer goods powerhouse Procter & Gamble (NYSE:PG) as an example. Shares of P&G are nearly twice their value from just five years ago. That’s in addition to the $15.25 worth of dividends dished out during that time, driving the stock’s total return up by about another tenth of its average price during this stretch. Not bad.

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Except, easy-to-own growth stock Alphabet nearly tripled in value during that same five-year stretch.

2. You don’t want to complicate (or raise) your taxes

Investors’ efforts to postpone and minimize taxes are understandable. But they’ve arguably become overblown. You have to pay taxes sometime, and you don’t want to crimp your overall returns just to avoid a tax burden in the current tax year.

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On the other hand, if collecting dividends now — even if you’re reinvesting them in more shares of the same stock — is more of a tax hassle than it’s worth, it might be easier just to avoid the headache altogether.

These scenarios are admittedly few and far between. Examples might include a young individual or couple who doesn’t currently own any dividend-paying stocks outside of a tax-sheltered account, or a high earner already earning a great deal of dividend income. The former would be forced to collect and add information to a form 1040 on only a small amount of additional taxable income, while the latter may find the additional dividend income is taxed at a much higher rate than their current dividend income is. It’s just enough to make you think twice about it.

3. You’re prone to a false sense of security

Finally, while it’s more of a philosophical trap one eases into than a sudden, rude awakening, dividing stocks pose the risk of making owners think they’re safer and more stable than they really are.

Take PG&E (NYSE:PCG) as an example. While the California-based utility company is in the business that’s seemingly best-suited for supporting reliable dividend payments — selling electricity to consumers — the business itself is far more complicated than it seems on the surface. The company was found to be at fault for a streak of wildfires that devastated California between 2018 and 2020, not only upending the stock to the tune of 80%, but forcing the company to indefinitely suspend the otherwise reliable dividend its stock had paid and improved since 2006.

Nobody saw it coming before it was too late.

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None of this is to suggest that all dividend stocks should be avoided at all costs. There are good reasons to own them, and there are plenty of solid dividend-paying names to choose from.

Rather, the point is that the dividend-paying portion of your portfolio should be as diversified as the growth portion is. And it should benefit from the same sort of regular check-ins just to make sure these seemingly stable companies are still as stable as they were when you first bought them.

In other words, you should only step into dividend-paying names if and when they work with a well-thought-out portfolio plan that can be adapted as situations change… theirs, and yours.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. James Brumley has positions in Alphabet (A shares). The Motley Fool has positions in and recommends Alphabet (A shares) and Alphabet (C shares). The Motley Fool has a disclosure policy.

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