Why Dividends are Irrelevant
Dividends Are Irrelevant
I bite my tongue when I hear that dividends are important, or that dividends somehow make what would be a good investment a great investment. But I can’t do it anymore.
Dividends are irrelevant.* But to play fair and to avoid my own confirmation bias, let me start with three big reasons why investors think dividends are important.
- It’s Income
Receiving income directly from an investment, without having to sell anything, is comforting. Especially for retirees. “So long as your investments continue to pay their dividends, and those dividends increase by at least inflation, your retirement income is secure, without you having to sell a single share.” That sounds good. Sign me up.
- Tax Treatment
In Canada, publicly traded Canadian stocks pay eligible dividends. Taxwise, eligible dividends are grossed up but then receive an offsetting tax credit that result in a relatively low total tax owing.
(Accountants please don’t get mad at me for this oversimplification).
If your taxable income in 2025 is lower than $57,376, you don’t pay tax on eligible dividend income. And not counting potential OAS clawback, eligible dividend income between $57,376 and $114,750 only results in just shy of 8% tax owing. Again, sign me up.
- Perceived Safety
“The companies I own share their profits with shareholders with nice dividend cheques. They keep paying and they’ve been paying them for years (i.e., like Canadian banks and utility companies).”
Investors think there’s a level of safety because the dividend income feels like it belongs to them. If it’s paid to cash in their account, or sent directly to their bank account, it can’t be taken away from them like a share price collapse. “Share price is down? I don’t care. I’m still getting my dividends.”
Three for three. Sign me up.
My counter arguments.
- It’s Income
When a company pays a dividend, the share price drops by the same amount. Though the optics of receiving a dividend might be comforting, it’s kind of like the company is selling shares for you. Why not just sell the shares yourself? You can just create your own dividend.
- Tax Treatment
From a tax perspective, capital gains > eligible dividends. You can defer capital gains for as long as you want, but dividends must be received when issued. With appropriate recordkeeping, you can control the exact dollar amount of the capital gain too. And there’s no gross up of capital gains taxes, so you don’t need to worry about OAS clawback like you would with eligible dividends.
The one benefit where eligible dividends “win” is for investors who can take advantage of the lower marginal tax rates. Still, I think being able to defer tax is more powerful.
- Perceived Safety
This is the one that irks me the most. Dividends don’t make your investment safer. They just make you feel safer. And that’s the big difference.
Every dollar paid out to you is a dollar the company can’t (or won’t) use to hire better people, build out better technology, or improve its products and services. That’s money that could have been reinvested to grow the business and make your shares worth more. Instead, it’s mailed out to you like a consolation prize.
And are we supposed to believe companies pay dividends because they have extra money lying around? Or is it because shareholders don’t trust the CEO not to waste it? Just asking those questions makes me wonder about how “safe” dividends really are.
More than anything, dividends create a false sense of security. Investors shrug at stock price declines because the quarterly cheque still shows up. Until it doesn’t. When a dividend gets cut (or eliminiated), not only do you lose the income, but the stock price usually gets hammered too. How’s that for safety? And don’t get me started about companies that borrow money to pay their dividends.
So where does this leave us?
Dividends aren’t free money, and they’re not a magical tax loophole. They aren’t a safety net either. They’re just one way of distributing capital back to you and most of the time they create more illusions than benefits.
What matters is the strength of the business and the total return delivered over time. If you want income, you can sell shares. If you want safety, you can look for durable companies. And if you want tax efficiency, capital gains are your friend.
This isn’t just me being nitpicky. This is corporate finance 101. Miller and Modigliani proved more than sixty years ago that in a world without taxes, transaction costs, or other frictions, dividend policy is irrelevant to a company’s value.**
Value comes from earnings and growth, not how or whether those earnings are sliced up and paid out.
Dividends feel good, look good, and sound good. But that doesn’t necessarily make them any good.
*Dividends are “irrelevant” in the technical sense because what matters is total return.
**I know those are ridiculous assumptions, but if we paired their findings with the anecdotal detail I’ve ranted about, a strong case could be made for just how irrelevant dividends are.
