Dividend strategy does not pay off! 3 major disadvantages for Swiss investors

In this article, we look at the dividend strategy that is very popular among private investors. As the title suggests, we don’t think this strategy makes sense. Below we take a critical look at it and show you why it is actually a no-go, especially for Swiss investors.

Dividends as the new interest

In the wake of the current and probably prolonged period of low interest rates, dividends are often glorified as the new interest rate. Even if the comparison is not quite accurate (an interest rate, e.g. on a bond, is fixed, a dividend is not), dividend strategies seem to have a magical attraction for many private investors. For example, you can find countless articles on the subject on YouTube, often with grandiose titles such as “Get rich with dividends” (Finanzfokus), “Simply collect dividends” (Bulle und Bär), “The best dividend shares” (Aktien mit Kopf), “What speaks for a dividend strategy” (Die Aktionärin) or even “Becoming an instant pensioner with a dividend strategy” (Der Weg zum Top-Investor). The basic tenor is always the same: “Dividend stocks are the better stocks”.

However, there are (rightly) more and more critical voices online: Sometimes this is postulated rather diplomatically, as with Finanzfluss (“Dividend strategies are not a good idea”, see video below in the show notes), sometimes a little more rustic, as with Sparkojoten (“Dividends are bullshit”). Incidentally, the latter sticks to the dividend strategy despite his clear verdict, which seems rather masochistic.

From dividend aristocrats & Co.

What is the dividend strategy actually about? Basically, with this form of investing, the investor only buys shares in companies that pay dividends. Among these stocks, the dividend model students are then often selected. It is actually a very simple concept.

The best known of these are the so-called “dividend aristocrats”. This term is commonly used to describe a company that has continuously increased its dividend for at least 25 years. This core definition is in line with that of the S&P 500 Dividend Aristocrats (source Wikipedia).

In German-speaking countries, Mr. Röhl’s term “dividend aristocracy” is also in circulation. The underlying selection criteria for inclusion in his two German and Swiss dividend funds (he refrains from global diversification) are dividend continuity and payout ratio as well as dividend growth and yield.

The MSCI High Yield Dividend is more advantageous and more broadly diversified. It contains around 320 companies that pay above-average dividends. The selection is based on the MSCI World Index, which contains around 1600 companies. The latter performs better in a long-term performance comparison (gross returns, i.e. including dividends but excluding costs).

Left pocket, right pocket

As a shareholder, whether directly or via an ETF, you are (co-)owner of the companies in which you are invested. This means that you participate in the stock market value. Your sources of income – if any – consist of realized capital gains and dividends. There are basically two types of listed companies: Companies that pay dividends (e.g. Daimler, UBS) and those that do not (e.g. Tesla, Amazon).

From a sober point of view, the distribution of dividends offers no fundamental advantage over reinvestment. This is because, as a shareholder in the company, you are simply paid back part of your own money periodically with the dividend payment. In the other case, or in the case of reinvestment, the money is left in “your” company. For the investor, this has the effect of “left pocket, right pocket”.

Missed opportunities and other disadvantages

Companies that pay relatively high dividends are often companies that are barely growing or are even in decline. Examples of this include major European banks, oil multinationals and tobacco companies. In other words, the dividend collector does not invest in all the enormously successful growth stocks on the stock market, such as Tesla (+378% price gain in the last 5 years), Amazon (+592%) or Facebook (+192%). This is because these companies consistently pay out 0% dividends.

Below we have listed what we consider to be the three biggest disadvantages of dividend strategies:

Disadvantage no. 1: High taxes

The most significant disadvantage for Swiss investors arises from our tax laws. As is well known, dividends are subject to income tax for private investors, while capital gains are tax-free. Depending on your individual marginal tax rate, your return on dividend securities can therefore be substantially reduced.

The worst case scenario for tax purposes is companies that pay dividends and whose share prices are falling. With such securities in the portfolio, you pay taxes on the dividends paid out year after year, even though the bottom line, i.e. cumulative dividends minus realized price loss on sale, results in no gains or even losses.

You can find out more about ETF taxation in our article ETF taxes Switzerland: Optimize your portfolio with these 4 tax-saving tips.

Disadvantage no. 2: Unfavorable risk/return ratio

By focusing on exactly one single selection criterion, you are only invested in a relatively small number of companies. This means you miss out on the only “free lunch” in investing, which you get thanks to broad diversification (see Diversification: not all eggs in the same basket). You are then not invested in all the promising small caps and fast-growing tech giants, which naturally pay little or no dividends, which means you are entering into a less favorable risk/return ratio.

Disadvantage no. 3: Higher costs

If you invest in a dividend ETF, you will often incur significantly higher costs (TER) compared to a “normal” ETF, i.e. one based on market capitalization, which also reduces your return, year after year. In the case of the “Dividend Noble” products mentioned above, for example, the costs amount to a whopping 0.95%, i.e. several times the price of a broad-based, established ETF product.

Speaking of costs: In addition to the product costs, the fees charged by the broker are particularly relevant. Interactive Brokers, for example, is characterized by very low fees (see also our detailed review). Competitor DEGIRO has also successfully positioned itself as a price breaker on the European market (see partner offer below).

– Partner Offer –

According to our experience and due to the low costs for ETFs, “DEGIRO” is currently a particularly attractive broker (link to DEGIRO review). If you are interested, you can register with DEGIRO via our partner link, which will give you Trading credits of CHF 100 (with conditions) and support our blog at the same time.

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Conclusion

Even if we consider the dividend strategy to be an aberration with serious disadvantages, we would like to try to come to a conciliatory conclusion. The key question is: what actually fascinates investors about the dividend strategy? First and foremost, it is probably the regular cash flows that end up directly in their account. Cool, passive income! Dividend distributions may also be practical in the withdrawal phase and for rebalancing (see also our article Rebalancing your assets).

Whether your motivation is cash flows, withdrawals and/or rebalancing, you can do all this without following a dividend strategy. Our suggestion: Simply choose one or more dividend-paying, broadly diversified, passive equity ETFs that are composed according to market capitalization.

Distributing? That’s also tax that I have to pay! Yes, they are. You pay tax on all dividends, regardless of whether they are from individual stocks, distributing or accumulating ETFs. However, the tax burden will be lower because you are investing in the entire market, including all the successful growth stocks that pay no or only low dividends. You also benefit from a more attractive risk/return ratio and lower product costs (TER).

This might also interest you

Scientific excursus by Gerd Kommer on the dividend strategy:

Disclaimer

Disclaimer: Investing involves risks of loss. You must decide for yourself whether you want to bear these risks or not.

Errors excepted: We have written this article on the dividend strategy to the best of our knowledge and belief. Our aim is to provide you as a private investor with the most objective and meaningful financial information possible. However, if we have made any errors, forgotten important aspects and/or are no longer up to date, we would be grateful if you could let us know.