Month: November 2016

Dividends vs Capital Gains

There are many people who claim that dividend investing is a bad idea because you end up paying more tax.

Although it depends on country, generally dividends are classified as income, and income is usually heavily taxed whereas capital gains are normally not taxed until you sell the investments. Investors typically sell all their investments when they retire. When investors retire, they are typically earning zero income (because they’ve stopped working), so any tax they pay as a result of capital gains tax is usually minimal.

If you invest in dividend-paying stocks, you are being taxed on those dividends, and in countries with progressive taxation, the tax you pay is usually very high because your salary from work is counted as income as well.

There is also an argument made that companies that pay high dividends sacrifice capital gains because money that the company pays out as dividends could have been reinvested back into the company for expansion.

One in hand is better than two in the bush

While these are all fair arguments, I still believe that investing in dividends is better even if you pay more tax. The reason is due to risk. A bird in the hand is better than two in the bush. When companies pay dividends, you get cold hard cash in your hands. If instead you sacrifice your dividends and instead allow the company to reinvest that money, you don’t know if that reinvestment will work or not. Most people employing a buy-and-hold strategy typically wait multiple decades expecting capital gains to accumulate throughout that time, and when they retire they sell their investments. However, if you wait three or four decades and amass large capital gains, what if, just before retirement, there is a very large global recession that sends asset prices down? Decades of work has been flushed down the drain.

Money printing, negative interest rates, automated trading, and high leverage have made capital gains unreliable

Dividends are simple. A company sells something, they make money, pay their expenses, and a portion of whatever is leftover is given to investors as dividends. Dividend payments therefore depend on the quality of businesses, the quality of their management, products, services, etc.

Capital gains, however, are completely different. In today’s world of constant money printing and stimulus and high leverage products that increase volatility, it’s hard to trust asset prices because asset prices can be instantly manipulated. Asset prices are now so divorced from reality that it’s difficult to know what real or fundamental value is. If a bubble never pops and is continually inflated, is it a bubble?

In my opinion, the lost two decades in Japan following the crash in its asset price bubble in the early ’90s will play out in Western countries. Japan was an economic leader but the crash of the ’90s was its peak, and since then they have simply tried to reinflate their economy with no success, and the economy has gone sideways ever since.

nikkei225-source
The Nikkei 225 since the ’80s

What has played out in Japan will play out in Western countries where peak growth has been realized. We will see a zigzag pattern as stock markets crash and then are reinflated before crashing again, and this continuous forever. The best way to make money in such an economy is to forget about prices and focus on dividends.

Dividends and capital gains are not necessarily a trade-off

Empirically, dividend-paying stocks don’t necessarily perform worse. Below is a chart of the S&P 500 index versus the S&P 500 Dividend Aristocrats index.

Dividend Aristocrats vs S&P500
The S&P 500 Dividend Aristocrats index vs the S&P 500

Source: https://www.indexologyblog.com/2014/12/12/inside-the-sp-500-the-dividend-aristocrats/

Appeasing Donald Trump Supporters

The week before the US elections, I remember being overcome by a surreal feeling. I was worried because I feared Donald Trump would win. I was always concerned about this, so many months ago I purchased over $20,000 worth of GDX (a gold mining ETF) and about three weeks before the election I bet $50 on Trump to win at $5.00 odds. I had a feeling the events of Brexit would play out again. Just by browsing various Internet forums, I could feel the distrust in the American people. I could feel the pain and anger they were feeling. I knew that the markets were wrong. Those who feel they have been disrespected by the elite live in a completely different world to the investors making the bets.

It turned out I was right. Donald Trump won. It all started to go wrong a little before lunch. I was watching both the betting odds as well as the ASX200, the main Australia stock market index. The ASX200 surged initially but at lunch it completely turned around and started to crash. The betting odds also turned around. I went for a walk in the gardens during lunch. When I left the office the probability of a Trump win was about 20% but when I came back it was around 60% and was climbing fast.

Everyone around me was shocked. I am pretty sure everyone expected and wanted Hillary to win. One of my coworkers I think is a closet Trump supporter but by far most people didn’t want Trump to win.

My concern is that this victory empowers the crazies. The racists and sexists who believe it’s okay to bully women and non-whites will have the power of the government behind them. It is illegal in workplaces to sexually harass women, but when the harassment is done by those more powerful than you, you have no choice but to submit. There’s no telling whether Trump’s racism and sexism will result in policies that will disadvantage women or non-whites. Some people say he will moderate his position. Just because someone boasts about grabbing women “by the pussy” it doesn’t mean he will necessarily overturn legislation that criminalizes such behavior.

Among those who are disgusted by Donald Trump’s behavior, there is a lot of wishful thinking. The reason why the markets were wrong about a Trump victory was because no one wanted to believe that it was possible, so the suggestion that it could happen was easily dismissed. There was a lot of wishful thinking, and I think yet again people are engaging in wishful thinking by entertaining the idea that Trump will moderate his views or that he was only acting crazy during the campaign.

Supposedly Trump was elected mainly by working class people in swing states who were fed up with wealth inequality and the dominance of Wall Street. I don’t see how Donald Trump will fix any of that. His idea of applying a tariff on Chinese goods will only lead to a protectionist trade war. China will simply retaliate by not buying American exports such as Boeings, and this will only lead to more job losses. Meanwhile, the American working class is fixated by feminism, multiculturalism, Muslims, and homosexuals as if they are the reasons why they’re poor. It is as if rich people eat cake and everyone else fights over the crumbs. Instead of focusing on why the rich are eating all the cake, the white working class is fixated by the crumbs eaten by a Mexican person.

Now more than ever, the idea of a universal basic income is starting to sound good. Basically you tax the rich and give, say, $10,000 per year to everyone. This ensures that everyone has enough money to live. Technological advances through automation and robots as well as artificial intelligence as well as free flow of labor and capital will all create immense chaos. It is all part of the creative destruction of capitalism, and even if, as a whole, we benefit, there will be losers, and there needs to be a way of appeasing these losers. The easiest way to do it is to simply transfer money to them or, to make it fairer, to transfer money to everyone so that no one needs to work.

All in all, I’m trying not to think too much about politics. We don’t have much control over what happens in the world, so we should try to think about what we can control.