Investment strategy: focus on dividend or capital appreciation?

[desmachien]

I’m trying to define my investment strategy for the coming decades, but I’m facing kind of a dilemma.
My idea is to build a portfolio which generates income that replaces (part of) our paycheck.

Where I live, Belgium (Europe), the tax situation is quite unique:
The tax burden in our country is among the highest in the world, but we do not pay any tax on capital appreciation. We only pay tax on dividends.
Dividends from domestic stocks are taxed at 25% and on most international stocks (depending on tax treaties) we have to pay an additional 15% tax (so 37.5% in total).

From an efficiency point of view it’s better to focus on capital appreciation while investing, so avoiding stocks/ETF’s that pay a dividend.
Because the dividend approach means around a 1% yearly tax cost on our total portfolio (37.5% tax on 3% dividend yield).

However, psychologically I feel more comfortable tracking cash flow from a portfolio, than tracking ‘net worth’.
As the latter is more volatile and more intangible in terms of tracking towards our goal.

I would like to hear some opinions on the trade-off we need to make.

[milesdividendmd]

In general it only makes sense to pay attention to total returns.

Even ignoring the tax implications of dividends versus capital gains in Belgium,there is no difference between dividend paying stocks and non-dividend paying stocks (other than a slight value tilt towards dividend paying stocks historically.)

When you add in your unique tax laws, I would run away from any investment in individual dividend paying stocks.

I would focus on low cost tax efficient index funds akin total market funds and S&P 500 funds.

[Le Barbu]

Sounds like you're young and beginer investor. If your nest egg is still small (accumulation phase) you should focus on:

1-Save a lot (this is the most important of all)
2-Find a bank/broker with low cost transaction with possibility to trade with USD + Euro
3-Buy low cost broad index funds
4-rule of thumb for asset allocation 1/3 local/home (VGK or VEA), 1/3 US (VTI) and 1/3 emergent markets (VWO). If this sound to agressive for you, lets put 25% bonds (like EU) and split previous stock ETF 25% each.

You probably be able to adjust for tax saving down the road. If you have some kind of tax shelter, your income etc. Probably, trying to avoid completely dividends just ends paying higher fees or any other tradeoff. Are you sure there is NO way to work arround this dividend tax rule, legally I mean ?

Do you speak french ?

[desmachien]

Most ETF’s to which I have access, exist in 2 versions: capitalization (dividends reinvested) or distribution (dividend payout)

The ‘problem’ is that in the end I want an income generating portfolio.
But due to my tax situation, It is more efficient to generate income from my portfolio by selling parts of it.
I understand that selling portions or receiving dividends is the same from a total return perspective.

But psychologically / emotionally it feels different.
To track my progress it feels artificial to calculate the (potential) income based on a SWR.
Mainly because the value of my portfolio will fluctuate out of my control.
During a downturn it would look like I’m making no progress, whereas a dividend income would remain fairly constant.

Am I missing something?

@ Le Barbu
I’m from the Flemish part of Belgium, but do speak some French.

[Le Barbu]

For me I'm french but do know some english !

I understand your "psycologic/emotional" struggles.

But went you say "it is the same from a total return perspective", you prove you know how it works but still dont want to deal with downturns.

First option, You can just tell yourself that your plan is the good one and stick to it wathever happen. (my way to go)

Second option, You can adjust your A.A. (more bonds or fixed assets) when you get close to the end of the accumulation phase. (most recommended way to go)

Both are good, depends on you

I choose the first because I know how I behave in dowturns. The second is more consistent but total returns are likely to lag the other on the long run (25 years+)

[skyrefuge]

1. I understand the emotional appeal of dividends. However, this is mrmoneymustache.com, where we understand that making emotion-based decisions can lead to some pretty bad results, and so we attempt to adjust our minds to overcome our base emotional instincts. So a giant SUV might make us feel safe, but we aren't dumb enough to buy one; air-conditioning might make use feel more comfortable, but we aren't dumb enough to run it 24/7; restaurant lunches might make us feel pampered, but we aren't dumb enough to buy them every day. And dividends might make our income feel more steady, but we aren't dumb enough throw our money away into sub-optimal investments. So if I were you, I would put some effort into adjusting your brain.

2. To that end, dividend payouts may be more volatile than you realize. In the US, say you owned enough shares of VTINX (S&P 500 index fund) in 2007 to produce your necessary income of $1000 per month. Here's how that income would have changed over the next 6 years:

2007: $1000
2008: $1008
2009: $847
2010: $791
2011: $903
2012: $1088
2013: $1189

"$791" sure doesn't equal "about $1000", at least not in my mind.

In order to have generated that $1000/month income from dividends in 2007, you would have needed a stash of ~$630,000.

In contrast, if you had started with only $300,000 and simply withdrawn/sold 4% each year, that would have been sufficient to generate a much-more-steady $1000/month income for the entire time. And while your net worth would have certainly been volatile over that period, your balance at the end of 2013 would have been $341,846, or 14% greater than when you started.

3. This highlights that in the US at least, the current dividend yield of the stock market (~2%) is significantly lower than the assumed SWR (~4%). That means someone planning on living only on dividends has to amass a stash twice as large as someone living from total return. Which means the dividend investor has to spend many more years working than necessary, and will likely die with a giant pile of unused money.

4. In terms of tracking your progress, while you're working and saving, the chart of your increasing net worth will look much smoother than a chart of the stock market. Yes, you might see it drop, but the drops will be less steep and shorter than the stock market drops. For example, my net worth took a downward path between the end of 2007 and the beginning of 2009, but it had already risen up and reached a new peak by the end of 2009, while the US stock market price didn't return to its 2007 peak until 2013 (and over that period the amount I was saving each year was only about 10-15% of my total worth). Furthermore, during those times when you're seeing "no progress", you should be telling yourself that's exactly what you want to see, because it means that you're buying shares at great low prices.

[Breaker]

I would suggest that in order to avoid at least some of the tax on dividends that you look at stocks that are "buying back" their own stock.  This has the effect of making the price of the stocks you hold rise and no dividend to tax.  I have seen this referred to as untaxed dividends.

After reading Skyrefuge's post I will be doing some math and see if his calculations hold for me.  Or (hopefully finding the math done for me) and may revise my investment strategy to include draw down as well as collecting dividends.  Maybe just do a draw down and continue to reinvest dividends.

[Grog]

In Switzerland we have to declare dividend for accumulating ETF, even if they are never distributed and we never see them, but our system wants us to declare them anyway, which can be tricky to find out in the documentation of the ETF, foremost for synthetic one.