Some income-oriented investors are attracted to dividends because they view these stocks as less risky, and perhaps more stable. While dividends are one way to generate income, they are not the only way to produce cash, and investors should be aware of the potential tradeoffs that accompany a focus on dividends. For example, prioritizing dividends in your portfolio could come at the expense of diversification, flexibility, and total return.

Diversification. By investing in only companies that distribute cash dividends, investors are limiting their opportunity set. The average proportion of firms paying dividends in the US was about 52% from 1963 through 2019, meaning an investor focusing only on those stocks is missing out on nearly half of investible US companies. Holding only dividend-paying stocks may limit opportunities for global diversification as countries have varying levels of dividend payouts. This approach may also exclude significant amounts of smaller companies that are not yet paying out.

Flexibility. There are inherent consequences of any future tax rates and policy changes that increase uncertainty around future dividends. For example, if tax rates on dividends are raised relative to tax rates on capital gains, companies may decrease cash dividends and increase stock buybacks.

Total Return. For investors in need of income from their investments it may be more beneficial to focus more on total return, which includes dividends as well as stock appreciation. Investors can sell securities to generate cash instead of relying on businesses’ payout policies.

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