3 Reasons to Avoid Dividend-Paying Stocks | The Motley Fool (2024)

It's hard to write negatively about dividend-paying stocks because there's so much to like about them. They can deliver a lot of income, for example: If you have a portfolio of stocks worth a total of, say, $300,000, and it has an overall average dividend yield of, say, 4%, you can expect $12,000 to roll into your account every year -- about $1,000 per month. That can be very welcome not only in retirement, but also if you're far from retirement because the money can be reinvested in more shares of stock.

Still, here are a few reasons you might think twice before loading up on dividend payers.

1. Dividends are not guaranteed

For starters, dividends are not guaranteed. Companies will generally not initiate the payment of dividends until they have reached a stage where they have fairly dependable earnings because they do not want to miss any payments. That would look bad to existing and potential investors and might cause the stock price to take a hit, too.

Nevertheless, there have been plenty of times when companies -- even well-known and well-regarded ones -- have reduced their payouts or suspended them or even eliminated them entirely. When there's a recession, for example, and many companies are struggling, it's common to see lots of dividend shrinkage. And if any particular company is struggling, even in a strong economy, a dividend cut is a helpful way for it to conserve its cash.

In 2020, for example, facing several challenges including a scandal, Wells Fargoslashedits dividend by a hefty 80%. It has increased it a few times since then, but it's still belowthe pre-cut level. More recently, the telecommunications company Lumen Technologieseliminated its payout in November, alongwith selling off part of its business, in order to strengthen itself financially.

2. Dividend payers may not grow quickly

Next, dividend payers in general may not grow as quickly as you'd like, even as they can be less volatile and less risky. Remember, that when a company has earnings, it can deploy that money in a variety of ways. It might pay down debt, for example, or it can aim to reward shareholders by buying back stock (ideally only when the stock is undervalued). It might use that money to further its growth, too, such as by hiring more workers, building more factories, spending more on research and/or advertising, acquiring other companies, and so on.

And it can use some of that money to pay dividends. Clearly, companies that are growing briskly or want to grow briskly may not pay dividends, as they want to spend as much as possible on growth. Netflix has grown at very rapid rates over the past decade or two, but it pays no dividend. (Its stock is down sharply over the last year in part due to the overall market's downturn and in part due to increased competition.)

So if you're interested in loading your portfolio with growth stocks, you might be less interested in dividend payers. Some growth stocks, such as Appleand Nvidia do pay dividends, but they often sport smaller yields than slower growers.

3. You may not want to invest in individual stocks

You may be interested in dividend stocksbut not have the time, skills, or interest to study stocks and carefully choose individual ones. That's fine, and it's not a dealbreaker, either. You can always just opt for simple, low-fee, broad-market index funds. They're great for any investor, and since they tend to include plenty of dividend-paying stocks, they also offer dividend payouts to their shareholders. The SPDR S&P 500 ETF (SPY), for example, which tracks the S&P 500, recently yielded around 1.5%.

Still, owning dividend-paying stocks can boost your returns

Despite the points above, there remains a strong case for investing in dividend-paying stocks. For one thing, while many may grow slowly, plenty don't. And, in fact, more than one study has found that dividend payers tendto outperform non-dividend payers. Ned Davis Research and Hartford Funds, for example, found that between 1973 and 2021, dividend-paying stocks grew at an average annual rate of 9.6%, while non-payers averaged 4.8%.

So approach dividend-paying stocks with your eyes open, and don't assume that they're only for retirees or risk-averse investors.