Dividend Stocks – Good, not Magical

People concerned about an overpriced stock market often ask me whether they should add dividend stocks to increase their returns. When I press further, the logic goes something like this: if the stock market is flat (no growth), at least I get the 3% dividend yield to live on.

Let me start by saying that I like dividend stocks. However, my inner finance geek cringes when I hear people misunderstand how dividends work. When a company pays a dividend, the stock price typically goes down by about the price of the dividend. Why? Money paid out today means there is less money reinvested in the business to pay to shareholders in the future.

Again, it’s not that dividend stocks are bad. They just aren’t magical. Dividends move money around. They don’t create wealth.

So why do I like dividend stocks? Dividend stocks tend to be low priced stocks (a.k.a. value stocks). When you pay a low price, you can expect above-average returns over long time periods.