Author Topic: Dividend-based ETF's vs Regular ETF's - Better Long Term Strategy?  (Read 591 times)

cbarlow

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Heyo,

Young investor looking for some quick advice.

Have a blend of index funds (VTI, QQQ, VYM) and need someone to talk me through why I shouldn't focus on index funds with higher-yield dividends, especially if you plan on trying to rely on the dividends as a source of income later in life.

I understand that regular ETFs have much more room for growth than high-yield dividend ones, but if I have say $500,000 in VTI, those dividends won't pay nearly as much as $500,000 in VYM. Sure, I'll be able to reach $500,000 putting my money into VTI quicker, but won't I have to sell all that off to get that money into more dividend-based stocks as a source of income and thus take a huge hit on long term capital gains???

I guess I'm just thinking $500,000 sitting in an account with no dividends isn't as nice as $500,000 in diversified dividend-based stocks in terms of monthly income and earlier retirement. Why don't more people focus on investing this way?

Hope I'm making sense!



EvenSteven

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Re: Dividend-based ETF's vs Regular ETF's - Better Long Term Strategy?
« Reply #1 on: April 04, 2019, 08:29:21 AM »
The dollar value of your account will go up over time. It doesn't matter whether that increase in value comes in the form of dividends or share appreciation (if you ignore taxes). Total return (dividends plus capital gains) if what matters. When a dividend is paid, the share price goes down by the amount of dividend paid, so it's not free unaccounted for money.

There is nothing wrong or suboptimal with selling shares for dollars in retirement.

Arbitrage

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Re: Dividend-based ETF's vs Regular ETF's - Better Long Term Strategy?
« Reply #2 on: April 04, 2019, 08:32:17 AM »
Dividends are not free money.  When a company distributes dividends, that value comes out of the stock price.

There are plenty of opinions, educated or not, on why companies that pay dividends/grow dividends/whatever dividends are better investments than companies that do more stock buybacks (which increase the stock price), acquisitions, or whatever.  There is not a consensus.

What is definitely true is that dividends are not as efficient as equity price increases from a taxable standpoint.  When you are paid dividends, you pay taxes on those, even if those are used to reinvest.  Capital gains don't get taxed until you sell (minus the occasional fund distributing capital gains - but a good index fund rarely does that).  Your deferred taxes, in essence, get to keep compounding.  If you are in the accumulation phase - not withdrawing - and you are talking about a taxable account, I would recommend not going with high dividend payers.

If it's in a tax-advantaged account (401k, IRA, HSA, etc.), and/or you are withdrawing funds on a regular basis, go nuts with your preference.

cbarlow

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Re: Dividend-based ETF's vs Regular ETF's - Better Long Term Strategy?
« Reply #3 on: April 04, 2019, 03:47:38 PM »
Makes perfect sense thank you!

MoneyTree

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Re: Dividend-based ETF's vs Regular ETF's - Better Long Term Strategy?
« Reply #4 on: April 04, 2019, 07:53:59 PM »
I just posted about trying to take the exact opposite approach, finding etfs that have lower or no dividends at all.

It really depends on your situation/strategy.

Dividends are nice and can help smooth the ride, but as Arbitrage mentioned, they are also essentially forced recognized income. They are taxed at your long term capital gains rate. But the key difference between dividends and long term capital gains, and the reason I'm actually seeking to lower my dividends to a certain extent, is that you can choose when and how much capital gains to recognize.

In retirement, you can use this to your advantage to stay in the 0% LTCG bracket if your spending needs are low enough. You can also strategically use Tax Loss harvesting or Tax Gain Harvesting to further control future income recognition.

This is all flexibility you don't get with dividends. But then again, with dividends, it is a nice assurance to know you will have regular, generally consistent income. I don't get all riled up if someone chooses to follow a dividend strategy.

To each his own. Good luck!

Andy R

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Re: Dividend-based ETF's vs Regular ETF's - Better Long Term Strategy?
« Reply #5 on: April 04, 2019, 08:26:34 PM »
Welcome to the forum.

need someone to talk me through why I shouldn't focus on index funds with higher-yield dividends, especially if you plan on trying to rely on the dividends as a source of income later in life.

The problem is your psychological need to use dividends as a source of income is not based on any reasoning other than the feeling good.

Dividends are not some sort of separate money.

A company has earnings. It pays out 20% or 80% or any other amount as dividends, so dividends are arbitrary and have no meaning. It can also pay dividends from retained cash or from selling down assets. Dividends are arbitrary. The idea that selling shares will go deplete capital ye living off dividends won't is false for this reason.

By not reinvesting dividends, you are taking from your total return.
By selling shares of the same value, you are taking from your total return.
They are not different.
You can even see it when a fund goes ex dividend and the fund drops the value of the dividend.

The problem comes from falsely thinking dividends are have some sort of meaning about a company like earnings, then you are investing in a concentrated set of companies and lack diversification.

Further reading
https://www.cnbc.com/2016/12/08/dont-buy-in-to-the-dividend-fallacy-new-academic-paper-warns.html
https://www.bogleheads.org/wiki/Why_did_my_fund_unexpectedly_drop_in_value
https://www.bogleheads.org/forum/viewtopic.php?f=1&t=258311
https://www.forbes.com/sites/jimdahle/2018/11/11/five-reasons-to-avoid-focusing-on-dividend-stocks/#9b996ad74796
https://www.youtube.com/watch?v=UpXI_Vd51dA&t=9s
https://earlyretirementnow.com/2019/02/13/yield-illusion-swr-series-part-29/
https://retirementresearcher.com/can-rely-dividends-income/
https://www.bogleheads.org/forum/viewtopic.php?f=10&t=274340&start=50#p4411037