The Dividend Myth

We have written a lot lately about the belief that the stocks that pay dividends are negatively impacted by changes to the tax code, specifically changes that increase the rate at which dividends are taxed. Our own study of history, however, proves no such thing. Historically, stocks that pay dividends perform well on a relative basis when compared to non-dividend-paying stocks, regardless of changes to the tax code.

Now that major parts of the fiscal cliff have been resolved, concerns over the future performance of dividend-paying stocks should be appeased for all except those individuals earning more than $200K or married couples earning more than $250K. These taxpayers will see an increase in their dividend tax rates over 2012. But to those who have incomes high enough that they see their tax rates on dividends rise in 2013, history may not be the only consideration for keeping these positions.

Positive historical trends can be interrupted in short stretches when the sentiments of investors suddenly become negative. Consider, however, that pension funds, endowments, insurance companies, IRAs, and 401(k) accounts collect 75% of all dividends paid. Since these entities and tax-deferred accounts do not pay taxes on stock dividends, they would have no incentive to sell for fear of tax changes. There are enough buyers and holders of dividend-paying stocks, that the chance of a sell-off only affecting dividend-paying stocks seems very remote.