Distribution of dividends – do without?

It reminded me of my Uncle Heinz, who insisted on washing his old VW Beetle every Sunday, even though the paintwork had long since been lost. “Mark,” he said, “it’s not about whether it makes sense, it’s about the good feeling.” Well, that’s exactly how many people seem to feel about dividends – a good feeling that sometimes trumps common sense.

Dividend strategies have many followers and are considered solid. But where this reputation comes from remains a mystery to me. Let me use dividend stocks and their disadvantages to explain why I think dividend payouts are not necessarily the holy grail of investing and how, with a different strategy, you might soon be driving the Porsche you’ve always wanted – and not Uncle Heinz’s old Beetle.

The compound interest effect and dividend distributions

When I got my first savings account as a child, I was thrilled by the idea that my money would grow through interest. “It’s like magic!” I exclaimed enthusiastically. And even today I know that the compound interest effect is powerful. Every franc that is left in the company continues to work for you. But dividend payouts interrupt this growth process. Because every time a dividend is paid out, capital is withdrawn from the company that could otherwise continue to grow. This means that your investment loses potential growth.

I like to compare an efficient dividend strategy with planting a tree. You look forward to the fruit it will bear one day. If you always have your dividends paid out directly, it’s like picking every apple, no matter how small, straight away. The tree hardly has a chance to thrive. But if you let the tree grow and look after it, it will eventually bear so much fruit that you can harvest a whole basket – every year!

Taxes – the unpleasant passenger of dividend distributions

Imagine you’re on a leisurely Sunday drive in your classic car – the wind in your hair, the sun on your back. But your old friend, the taxman, is sitting in the passenger seat. And he reminds you every few minutes that you have to pay a tax. Sounds annoying? It’s exactly the same with taxes on dividends.

With few exceptions, dividend distributions that flow into your account are taxed. It’s as if the state is standing at the end of the street with open arms, grabbing a piece of your hard-earned pie. In other words, some of the money you have worked so hard to build up goes straight into the state coffers. In contrast, undistributed profits can remain in the company and be reinvested more efficiently for tax purposes.
So here’s a little reminder of an old saying: “Patience is a virtue”. When investing, you could add: “Patience is a fortune”. Let compound interest work its magic and concentrate on long-term growth instead.

Innovation despite high dividends? Not a chance

The fact is that many companies that promise investors high dividend payouts have already passed their growth phase. They are focusing on stability rather than exciting new projects. Instead of investing the money in researching new technologies or developing ground-breaking products, they prefer to distribute it to shareholders. These companies are often reminiscent of the good old lawnmower: reliable, but without surprises.

Growing companies, on the other hand, reinvest their profits in innovative projects. They focus on research, development and expansion. The result? Higher share price gains in the long term and the opportunity to benefit from new developments.

It might therefore make sense to change your focus – away from the long-established dividend payers and towards the innovative companies that reinvest their profits. This way, you really benefit from the fruits of innovation and maximize your return in the form of attractive share price gains.

Comparison – dividend income vs. capital gains

To put it in a nutshell: Dividends offer an immediate, but often small, return. It’s a bit like eating a small piece of chocolate every day – satisfying, but not particularly filling. On the other hand, there are the capital gains that can result from reinvested earnings. It’s more like the big turkey at Thanksgiving – it takes time to develop, but when it does, it’s really worth it.

So dividends may seem attractive at first glance, but the disadvantages resulting from the wrong dividend strategy cannot be denied. So perhaps it’s time to rethink your investment strategy and consider whether you really want to settle for the little pieces of chocolate and sacrifice growth in the process. It might be smarter to shift your focus away from dividend stocks and towards promising innovative companies. Let your assets work and grow so that you can achieve your financial goals in a much more satisfying way.

Yours, Mark Stock©

P.S.: By the way, I was able to take the rose-colored glasses off my friend. After our conversation, he started looking at high-growth companies and paying less attention to the mere distribution of dividends. Perhaps that would be something for you too?

Mark Stock is a member of the Point Capital editorial team. “I am a stock market enthusiast and am passionate about economic history. I have been following the ups and downs of the markets for years and, of course, invest myself – preferably in shares. So my name says it all. Every month, I take up what I consider to be an exciting topic. And since the focus is on the content and not on me personally, I write under a pseudonym.”