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Misconceptions of dividend producing stock

March 2, 2009

(Self Disclosure:  My father is an investment manager whose portfolios and strategies include dividend producing companies.)

This is way off topic for me, but I’ve been really bothered by all of the anti-wealth sentiment that seems to be growing in the US… that somehow people with a lot of money are the cause of the economic collapse, or that they are hurting the economy by continuing to take their pre-collapse salaries.  This sentiment is routinely expressed (of course) towards the CEO’s of big firms, but also now for college basketball coaches.

Apparently, limiting the salaries of corporate/organization heads is not enough, and so right now there is growing sentiment that dividends should be taxed higher, since many heads of companies invest in these stocks to generate income, and by doing so avoid higher tax rates on salaries.

The article goes on to assert that the investment in dividend producing stocks led to greater speculation, which in turn led to the current market state.

One example of “speculative dividend investment gone awry” are the Madoff funds, where individuals and companies bought into his Ponzi scheme, and ended up paying taxes for dividends they never received. However, this had nothing to do with the real culprit of the crash, the mortgage-backed security.  The folks that invested with Madoff were duped and robbed.  They have nobody to blame but themselves for getting hoodwinked by one of the oldest investment cons in the book.   It doesn’t mean the underlying dividend system is flawed, and it doesn’t mean the dividend system contributed to the current market situation.

The reason why dividend income is taxed lower is that it has already been taxed.  The companies that offer dividends have already paid taxes on their earnings.  Companies (not funds) that offer dividends typically are older, more stable companies that have limited opportunity for growth.  By offering dividends, they offer an incentive for investment over another faster growing, but less established company.

The Christian Science Monitor article is wrong on several points.  Investing in dividend producing companies is almost always less speculative than non-dividend producing companies.  You are typically investing in companies that are producing positive cash flow, and in companies that have been around for a while.  This is far safer than investing in other types of companies/funds.  This method of investment is also not the sole domain of the super-rich.  Anyone can do it, and it remains a powerful tool for people looking to make safer investments in the market.

The government has meddled with investment strategies at its own peril.  They encouraged us to buy homes we couldn’t afford, and directly brought about arrangements for loan agencies to buy and sell bad debt. The last thing they should be doing now is discouraging us from investing in strong, stable companies.

It is my belief that we are going to get out of this bad market through “back to basics” economic policies and investment strategies, not by eating the rich.

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