Dividend investing is very popular. Many investors like to have their long-term savings in a collection of dividend-paying stocks. There can be good reasons for preferring dividend-paying stocks over other stocks, but I suspect that the main benefits are emotional.
For investors in the lowest tax brackets, dividends are taxed less than capital gains. This is one good reason to prefer dividends over capital gains. However, most of the dividend investors I know are in a high enough tax bracket that they would be better off with capital gains.
Some investors believe that dividend-paying stocks pay a larger total return (dividend plus capital gains) than non-dividend-paying stocks. All evidence I’ve seen says that this isn’t true.
Some investors believe that long-time consistent dividend-paying companies are less risky than other stocks. I have no opinion one way or the other on whether this is true, but I don’t think this is the dominant reason why some investors prefer dividend-paying stocks.
From my observations, the real reasons for dividend investing are emotional. It feels good to collect dividends. You still have the same number of shares and now you’ve got some extra cash. The fact that each dividend reduces the capital value of the shares isn’t front and center in the investor’s mind.
Dividend reinvestment feels good as well. The number of shares you own grows over time without having to invest more money. Of course, if the company had retained the earnings instead of paying a dividend, the result would be essentially the same. In the non-dividend case, your number of shares doesn’t rise, but each one is worth more.
To illustrate how this works, imagine that you’ve got 2100 shares of XYZ Corporation trading at $20 each. Over the course of a year, the value of the business rises 10%. If no dividend is paid, you’d have 2100 shares worth $22 each. But, if XYZ pays a $1 dividend, the shares would rise to only $21, and you’d be able to buy another 100 shares with your $2100 dividend. So you’d have 2200 shares worth $21 each. With or without the dividend, the total value of your shares would be $46,200.
When it comes time to live off your savings, it feels better to collect dividends and spend them than having to sell off some of your shares to generate income. Once again, there is no real difference when you go through the math, but it feels bad to see your number of shares dwindling even if the total value of the shares is identical whether a dividend is paid or not.
Hard core dividend investors may have good reasons for their choice that I haven’t mentioned here, but my own observations are that the dominant reasons for choosing dividend investing are emotional.