Yields of Dreams: An Informed Look at Dividends

Many Investors in recent years have developed a preference for stock dividends to generate income needs. In today’s historically low interest rate environment, such stocks are more attractive than the familiar bonds or bank CDs they used to buy and hold.

But dividend strategies with stocks are not the only way to produce income. Moreover, investors should be aware of the potential tradeoffs and unfamiliar investing risks that accompany a portfolio managed to provide income primarily in the form of dividends. While dividend-paying shares appear to have a reliable schedule (quarterly, in many cases), much like the bonds conservative investors favored for so many years, the cash to fund a dividend must come from somewhere, and it does so very differently than a bond.

We know the price of a stock is influenced by all expected future cash flows to the firm, and thence to shareholders. If cash is paid today in the form of a dividend (rather than be retained for future growth), the stock price — and total market capitalization — of the issuing company should be expected to fall by a corresponding amount, such as in hypothetical Portfolio A in Exhibit 1, below. That means, all else being equal, shareholders who receives a dividend are left with a equity holding made less valuable by that dividend.

Chart comparing methods of income generation
Chart showing income via stock sale - Portfolio B


A simple alternative method of raising cash for income when needed is to simply sell shares. Firms like Charles Schwab have $0 commissions with on-line trades. Exhibit 1 compares these two methods of generating income by contrasting hypothetical Portfolio A with the similarly valued Portfolio B. While Portfolio A receives income through a periodic dividend payout, Portfolio B generates it through a stock sale.

The investor in Portfolio A, in which a dividend is issued, ends up holding the same number of shares as were held prior to the dividend payout — but we assume that those shares have declined in value. The investor in Portfolio B holds a reduced number of shares with no value decrease because of no dividend payout. The two approaches arrive at the same place—both investors end up with $100 in cash and $1,900 in stock, notwithstanding potential trading costs or tax implications, if any. But the dividend approach has potentially greater downsides in contrast to the stock-sale approach.

First, the average proportion of U.S. firms paying dividends was about 52% from 1963 through 2019,1 meaning an investor focusing only on high dividend stocks excludes nearly half of all investible U.S. companies. A second consideration is that a dividend’s value, while not subject to stock price fluctuations, isn’t guaranteed. Just 10 years ago following the financial crisis, more than half of dividend-paying firms cut or eliminated those payouts.2 More recently, a venerable company that had consistently paid dividends for more than a century, General Electric, slashed its payout to just one cent a share.3 The UK’s Vodafone Group cut its full year dividend for the first time in two decades.4

Thirdly, investors lose flexibility with the timing and the size of payouts when they rely on company-issued dividends. With stock sales, an investor determines both the amount and the best income schedule for them. And lastly, dividend-focused investors tend to substantially under-diversify, typically owning only a limited number of stocks, thereby incurring unnecessary risk—the fewer the stocks, the greater the uncompensated risk.

Graph showing income facts - Exhibit 2

Source: Dimensional calculations using Bloomberg data. For constituents with reported returns of less than one year, returns shown since earliest date available. S&P data© 2020 S&P Dow Jones Indices LLC, a division of S&P Global. Dividend yield is calculated as the sum of dividends paid in calendar year t divided by end of year t-1 price.


When considering an investment strategy, it is equally important to assess the potential total return, which accounts for capital appreciation (or loss) alongside dividend income. High dividend yields does not mean high total returns. Exhibit 2 plots the trailing 12-month returns of S&P 500 Index constituents as of December 31, 2019 (each dot representing a company). Those companies with greater dividend yields—the dots located higher up the vertical axis—weren’t consistently those with a higher total return.

The need to prioritize income generation may be important for many investors, but that objective should not preclude other important investment considerations, such as diversification and flexibility. While the use of stock sales instead of dividends to create cash flow may involve trading costs and tax considerations, there are growth benefits for investing in companies that don’t currently pay dividends. An informed investment planning strategy focused on income should balance broader concerns such as longevity that do not exclude safer allocations into fixed income and annuity income approaches.


1Source: Dimensional, using data from CRSP. Stocks are sorted at the end of each June based on whether a dividend was issued in the preceding 12 months.

2Stanley Black, “Global Dividend-Paying Stocks: A Recent History” (white paper, Dimensional Fund Advisors, March 2013).

3Janet Babin, “GE cuts dividend to a penny per share. Why bother keeping it at all?M” arketplace, American Public Media, October 30, 2018.

4Adrià Calatayud, “Vodafone cuts dividend after swinging to 2019 loss.”M arketWatch, May 14, 2019.