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There are three key considerations that you have to take into account in adopting a
high-dividend strategy. The first is that some stocks with high dividend yields may be
paying much more in dividends than they can afford. It is only a matter of time, then, before
the dividends are cut. The second is that any firm that pays a substantial portion of its
earnings as dividends is reinvesting less and can therefore expect to grow at a much lower
rate in the future. Thus, you often have to trade off higher dividend yields for lower earnings
growth in the future. The third is that you as an investor will have a much greater tax cost on
this strategy, since dividends are taxed at a higher rate than capital gains.
While investors may buy stocks that pay high dividends as substitutes for bonds,
there is one significant difference. A conventional bond offers a promised coupon; in other
words, when you buy a bond with a coupon rate of 8%, the issuer contractually promises to
pay $ 80 a year for the lifetime of the bond. While issuers can default, they cannot
arbitrarily decide to reduce this payment. In contrast, a company does not con...
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This note was uploaded on 01/17/2012 for the course ECON 101 taught by Professor Econnorm during the Spring '11 term at Art Institutes Intl. Minnesota.
- Spring '11