November 25, 2024 – Explore the tax benefits and strategic advantages of investing in dividend-paying stocks in today's Lifetime Planning episode of the Financial Sense Newshour. We dive deep into dividend investing and look at the advantages this strategy offers, especially in today's current market. We explore why dividend-paying stocks, often overlooked in favor of growth stocks, can play a crucial role in your investment portfolio. Learn from the strategies of Warren Buffett, who emphasizes investing in companies with strong cash flows and a competitive edge. Understand how reinvesting dividends can significantly enhance your returns over time, backed by historical data and academic research.
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Transcript
Cris Sheridan:
Well, today we're going to discuss dividends for the long run and when it comes to taxes and income in particular. Welcome to today's Lifetime Planning Show. Today we're going to be speaking with Financial Sense Wealth Management president Jim Puplava. So, Jim, as long as I've known you, you have been relentless in your emphasis on blue chip dividend stocks. What got you interested in dividend stocks versus growth stocks?
Jim Puplava:
You know, Cris, it was really studying Warren Buffett. I've read just about every book you can on Warren Buffett because he's in my mind, one of the most successful investors in history. And if you look at what Warren Buffett does in the companies he buys, he buys cash flow. So he's buying companies if he buys the entire company. These are companies that have a strong monopolistic or moat in the business that they're in. They dominate it in one form or another. They generate and throw off huge amounts of cash or if he's buying a public company, the same thing. They pay a dividend with dividend increases because Buffett runs Berkshire Hathaway, it's an insurance company. Now what insurance companies do is they take your premium that you pay for car insurance, life insurance, disability, whatever it is, and they invest the money in bonds and the money they earn from bonds is their profit. And then out of that, they're going to have to pay out like for a life insurance settlement, a car accident, et cetera. What Buffett does and why he's one of the most successful insurance companies in the S and P is he buys companies instead of just bonds. So he's buying companies that pay a good dividend, generate huge amounts of cash, and that dividend goes up each year. And so if you just take a look at some of the dividend paying stocks that Buffett owns, Apple, Bank of America, Chevron, Coca Cola, American Express, Kraft, what's their characteristic? They all pay dividends. The dividends go up each year and they generate large amounts of cash. And the other thing is it's not just dividends, but it's also Buffett focuses on total return. Total return is capital appreciation and also the dividend. So the combination of the two is what makes Berkshire Hathaway what it is. And that's why I got involved in dividends. And quite honestly, it was the dividends for my portfolio that allowed me to put all three of my kids through college.
Cris Sheridan:
Jim, you recently wrote an article on dividends published on our website, and something that you mention on the show quite periodically is a number of books and resources. What are some in particular that you would point our listeners to that really shaped your thinking on dividends?
Jim Puplava:
Probably next to reading Buffett and Graham, there was a book by three professors out of London, I think they were London School of Economics, and it was called Triumph of the Optimists. It was a 101-year history of global investment returns in 16 of the world's largest markets. And I want to read some of the accolades on this book when I read this and saw this on Amazon. This is from Peter Bernstein, author of Capital Ideas and Against the Gods. No investor can afford to risk a penny in the markets without studying this book and absorbing its fascinating lessons. That advice applies whether you are a professional or amateur, a youngster or a hardened from experience, bold or conservative, this book is history at its most challenging and illuminating. The facts are astonishing, the presentation dazzling and the analysis brilliant. And the lessons profound. And as I said, it had a profound influence on me. When you read with this, it really made the case of not only stocks, but dividend stocks. And in this book, Cris, they talk about Since 1900, equities have averaged an annual return of 6.7%. This is over a hundred-year period. Bonds have averaged 1.6%. Here is the more significant thing that really made an impact on me, Tom, and I'm reading here from the book. On balance, over the years, capital gains outweigh losses. A US equity portfolio which started life in the year 1900 with an investment of a dollar, would have ended 2000 with a value of $198. Not bad a return even without reinvested dividends. This represents a Compound annualized gain of 5.4% a year. This significantly outpaced consumer prices, which ended 2000 at an index level of 23.64, or in other words, an annual inflation rate of 3%. The real gain was 2. However, had you reinvested the dividends, the annualized return was 10.1%, a significant increase by instead of $198, which is just a dollar growing from the growth in the market, that $100 invested in stocks with dividends, with dividends reinvested $16,797 versus 198. And that's the point hopefully I can drive home because half of the return of the stock market has come from dividends. If you aren't looking at cash flow, you're missing out on half of the market's return and a lot of its predictability as we'll get into here.
Cris Sheridan:
Okay, so you've made a strong case for investing in dividend paying stocks as it relates to Buffett's strategy and his approach to investing as well. Historically speaking, dividends are crucial, as you pointed out, to long term gains in the stock market. But there's another aspect to this that may not get as much attention and that's the tax side of the argument for dividends.
Jim Puplava:
Yeah. If you are single, the first $44,625 of dividends are taxed at 0%. And you can go all the way up to $492,300 this year and only pay a 15% tax rate. If you're married, $89,250 zero taxes. And you can go all the way up to $553,800 in a 15% tax bracket. Now let me throw a caveat. There's something called the Obamacare tax. And if you are single and you make $200,000, add 3.8% to the 15% tax rate. And if you are married and make $250,000, you can add another 3.8% to the tax rate. And the reason they give you favorable taxes on dividends is dividends are taxed twice. So let's say a company, an S&P 500 company makes a dollar in profits. The corporate tax rate now is 21%. So they pay 21% tax. Roughly, they have about 80 cents left over. Then let's say out of that 80 cents they have leftover in profit, they give you, the shareholder half of that. So they give you 40 cents. Well, what do you do as a shareholder? You have to pay tax on that dividend. So it's taxed twice. And a lot of people say, well, will they get rid of that? Let me just give you a little history. Beginning in 1987 in the Tax Reform act, they introduced a two-tiered system for dividends. Qualified dividends were initially taxed at 30% and later reduced to 20% in 2003. Then we had the 2009 American Recovery and Reinvestment Act. Remember, we were in the financial crisis. They temporarily reduced the tax rate on qualified dividends to zero percent to stimulate the economy. In 2013, with the new tax bill, they raised the tax rate. And then in 2017, the Trump tax cut lowered the tax rates on dividends to 0%, 15%, and 20%. So I'd still, Cris, rather pay 20% in tax on my income than 40%. So let me give an example. Let's take some high dividend stocks. We'll go with Verizon. Verizon's dividend is 6%, back out 15%. Let's say you're above that level and you're paying 15%, it yields 5.5% after taxes. Cris, I don't know anywhere that I could get five and a half percent tax-free unless I was buying a very low-quality municipal bond. So it's not just the fact that you're earning higher after-tax income than what you could get in things like T bills, Treasuries, or other type taxable interest investments, whether you're in a CD, a T bill, or let's say a corporate bond. But more importantly, unlike fixed income, that income is going up each year, which really is your inflation hedge.
Cris Sheridan:
Jim, one thing that we've discussed a number of times on the show here is dividend aristocrats. For people that have been investing for quite a while, they've probably heard that term and know what it is. Just for any of our listeners that may have not heard that term or know specifically what sort of companies are included in that dividend aristocrat category. Can you explain what they are and why these are companies that you invest in specifically?
Jim Puplava:
Well, a dividend aristocrat, to qualify, must have raised... Raised, that's the word. Raise their dividend 25 consecutive years in a row. They have to be financially stable. You will find them in mature industries, attractive yields, and also capital appreciation. And so those are the kind of things that make up the dividend aristocrats. There's about 65 dividend aristocrats. I mainly invest in dividend aristocrats. But you know, we're in some technology stocks that are newcomers to the dividend aristocrat world. A good example is if you own Microsoft. Microsoft started paying dividends in the last decade. Cisco started paying dividends, Intel. And a lot of that was criticism that these big tech stocks got the barons. And the Wall Street Journal kept running a series of stories on these companies that were buying back their stocks and they went nowhere. And all of a sudden, they start paying a dividend and raising those dividends every year, sometimes double digits, and the stocks took off. So there are some exceptions. I usually like to look at a company, if they're in a new industry, it's a new company, hasn't been around. But if they've been raising the dividend 10 years, then I might look at them. So that's one of the things I like about these aristocrats. They're predictable and they're reliable.
Cris Sheridan:
So clearly you have a dividend approach when it comes to your income account here at Financial Sense Wealth Management, and dividend aristocrats are a big part of that. What is it that you look for specifically, outside of just having a dividend, having a reliable track record of raising their dividends, what are some of the things that you use in terms of criteria for stock selection in your income account?
Jim Puplava:
I look for a 10% total dividend return. And let me explain this because a lot of times this confuses people. I look for a combination of dividend yield and dividend increase. Between those two, they have to equal 10%. So let me give you an example. Let's say a company pays a 4% dividend, but they increase their dividend 6% a year. Well, the dividend yield of 4 and the dividend annual increase of 6 gives me my 10%. So please don't misinterpret what I'm saying here that, you know, the dividends are 10% a year. That's not what I'm looking at. I'm looking at a combination of the dividend itself and the dividend growth as well. And another thing I also look at, in terms of screening and looking at companies, I always try to look for a dividend yield that is twice the dividend yield on the S and P. So if we were looking at the S and P on the day we're doing this broadcast, the dividend yield on the S and P is 1.44%. So I would look at a dividend yield of 3% or more. And then also, Cris, during market corrections, when stocks go down, I up that criteria to 4%. So like if you took a look at 2022, when stocks were going down, we were looking at dividend yields of 4 to 6%. And so right now, the current yield on the portfolio is currently 4.2%. And that has been growing. The dividend growth has been between 9 and 11%. Last year, last year was a slower year for us. We've been averaging over 10, 11%. Last year, the average dividend increase went up 9%. So once again, I look for a total dividend return of 10%, and that's made up of dividend yield plus dividend growth. Another thing to look at this. If you are seeing your income go up between 8 and 10% a year, what does this mean to you as an investor? What would this mean to you as a retiree? It means your income doubles every seven and eight years. How many of you retired today, as you take a look at your income, would love to see your income double in the next seven to eight years. That's why I like this. It's one of my best strategies, in my opinion, for keeping up with inflation.
Cris Sheridan:
So, yeah, in that case, why do you believe dividends are one of the most effective inflation hedges or ways to invest around inflation?
Jim Puplava:
Well, I mean, if you're investing in the stock market, you hope the stock market goes up, which it generally does longer term. But I like to remind investors, from 2000 to 2013, the stock market did zero. It went. It fell 55% and then from the middle of 2007 fell 60% between 2007 and 2009, and it took it another four years to 2013 before the S and P surpassed the level it reached in March of 2000. So there are extended periods. A good example. Also. We've talked about this on the show with our technicians. Between 1968 and 1982, the stock market went nowhere. Went nowhere. Bull market, bear market, bull market, bear market. It was just in this kind of trading range of bull and bear markets. And so it's one of the reasons why I like dividends, because I don't know where the stock market's going to be. Can you tell me where the price of real estate... Look what happened to real estate. Between 2009 and 2012, the price of real estate fell 40%. So, you know, even if you go into a hedge like gold, gold can drop. Gold dropped 50% from 2011 when it hit a peak. So a thing about a dividend, I don't have to worry about it dropping. I know it's going to go up each year. So dividends, as I mentioned, are reliable, they're predictable. And look what you can do with them. If you get a dividend, well, number one, you can spend it. Number two, you can save it. Or number three, you can reinvest it, which is what they talked about in the book Triumph of the Optimists, that if you reinvested your dividends, the compounding effect is one of the seventh wonders of the world. And once again, how many times have we had technicians down here that will say, I think it might do this, but nobody's going to... No technician is going to come on the show. They might give you a forecast, but, you know, once again, it's an educated guess. I can't predict where the market is going to be in December, but I have a high degree of confidence. I know where the dividends are going to be on our dividend aristocrats. In my mind, I prefer something that's reliable, I prefer something that is predictable, and I prefer something that's tangible, a return. Not to mention the fact that I'm going to pay half to virtually nothing in taxes on the dividends I receive. So that to me, Cris, gives me a greater reliability and predictability for not only myself, but also for my clients.
Cris Sheridan:
So summing up, as you pointed out, dividends have represented half of the stock market's long term return. You mentioned that very important book that has been written, Triumph of the Optimists. Dividends are also taxed at a lower tax rate, between 0 and 20% versus 37% for interest income. They provide a tangible inflation hedge. Historically speaking, they can be seen as being more reliable and predictable, especially if you're looking at those dividend aristocrats like we discussed. Of course, the key is to look at, when we think about the safety of the income and the reliability of those dividends, is to look at more established companies that have strong balance sheets. And so that is part of the criteria that you use, including, like you said, that 10% dividend return metric, as you explained.
Jim Puplava:
Yeah, it allows me to sleep at night. And the one thing I, you know, you guys are probably tired of hearing this example, but I use it because I don't want to use a preferential stock, but I use Coca Cola. During the financial crisis in 2007, Coca Cola ended the year at 30 bucks. So had you bought it at $30 in 2007? It went down in 2008 and it went down in the first part of 2009. So it went from 30 bucks down to 20. So you lost a third of your value, but that was half of the stock market's loss. The stock market lost 60%, Coke lost 30. But here's the important point that is going to drive home what I've been talking about. In 2007, they raised their dividend 8%. 2008, they raised it 8%. 2009, they raised it 8%. So, Cris, had you done nothing? Let's just say you never looked at your statement. You were in an RV going across the country, didn't have time to look at your portfolio, your income would have gone up 24% during a financial crisis. And when the stock market came back after March of 2009, by the end of the year, your Coca Cola was back up to 30. Today it's at 60.
Cris Sheridan:
Steady, reliable income, so long as you invest in the right companies.
Jim Puplava:
That's exactly right. So if you'd like to find out more about Financial Sense Wealth Management and how we can assist you, give us a call at 888-486-3939 or go to our website, financialsensewealth.com. In the meantime, on behalf of Cris Sheridan and myself, we'd like to thank you for joining us. Until we speak again, we hope you have a good rest of the week.
