DIVIDENDS: THE DOWNSIDE.

Daughter, Me, Grandson and the New Generation.

One Generation Leaves and Another Shows up. They took this picture the day after I got home from Arizona after saying goodbye to my Dad. In the picture above are Cindy and Zachary, Me, and Lucas Orion Crutchfield. I have this thing about babies and the miracle of life. They are so tiny and innocent, yet they have been programed for survival. Truly a blessing from God.

Are You Tired of Listening to Me Preach About Dividends? I still believe in their usefulness; however, I do believe I should let you know some of the pitfalls of this approach and give you some ideas about how to manage them.

1. The Dividend May Not Continue. I have not hidden this fact; however, the fact that some companies have a long history of quarterly dividends, does not prevent them from reducing them or even eliminating them all together. The past two years have seen strong companies like Pfizer, General Electric, and Dow Chemical cut dividends. General Electric and Dow Chemical CEOs virtually promised continued dividends at current levels only to drastically reduce them a short time later. The lesson here is that, rather than depend on what the executives say, do your own evaluation of the company's ability to continue dividends. Looking at things about the percentage of cash flow the company is paying out in dividends or the amount of cash and debt on the company balance sheet will give you an independent measure of the probability that the dividend will continue.

2. Sell Right After Dividend Cut. This is not a good strategy because not only will your income be reduced because of the dividend cut, the value of your stock will almost certainly drop. If you are unable to predict the dividend cut you stand to lose both income and principal after the cut. In fact, you may be better off buying more at the lower price right after the cut. Statistically, those who buy right after a cut usually do far better than those who sell.

3. Diversification Can Suffer. Although I am not adamant about staying totally diversified, I do believe that concentrating all your investment portfolio in dividend paying companies makes it more difficult to diversify which can increase your overall risk. Unfortunately, many higher dividend stocks tend to be among Real Estate Investment Trusts, Utilities, Master Limited Partnerships, and Business Development Companies. It is difficult to get a diversified portfolio by concentrating on these companies. Even though they pay lower dividends, you are usually well advised to diversify into other industries like telecommunications, energy, and technology Yields in these companies are usually half that of the high dividend industries; however, they still beat the 1-2% paid in banks.

4. Lower Growth Potential. A company that sends out a higher percentage of its cash flow in dividends should be able to earn a higher percentage return on that capital than you can; therefore, in the long term, you might accumulate more wealth by letting the company reinvest your capital than paying you a dividend so that you can reinvest it. This might not always be he case but you should always consider the possibility.

5. Tax Issues. The company has to pay tax on the earnings it distributes to shareholders. You also have to pay tax on the money after you receive it. While dividends received are taxed at a lower rate than ordinary income, this may not always be the case. There is considerable pressure to increase taxes on investment income and the preferred rate may become a thing of the past in an environment where many voters are of the opinion where we need to increase taxes the so-called rich.

I Still Favor Investing For Dividends. But I am aware that there is a downside that has to be managed. Perhaps we can discuss this more in the coming year. Merry Christmas and Happy New Year to all my readers.