Dividends Aren’t For Taxable Accounts

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This article is an outgrowth of my own research on how your taxes reduce the money you have in retirement to spend. Those taxes come from many directions while you are working and then when you are retired. Most people accept them as a necessary evil to increase their net worth and accumulate a retirement nest egg. One of my very early articles, “Surviving the Tax Bite In Retirement” in 2015, suggested how to use the taxable account with this bullet point:

Use more tax-efficient investments in your taxable account rather than dividend-paying stocks, once you get to higher income levels if you have significant RMD commitments.

As it turns out you should almost always use more tax-efficient investments in your taxable account, especially during your accumulation years.

In that article, I laid the groundwork for why the taxable account will never outperform your IRA or Roth, at least for positive returns. It can duplicate the performance of the Roth at least up to a point, where no money is withdrawn and its basis is “stepped-up” for inheritance. Another article, “ The Taxable Account As A Roth Substitute” explains this in more detail.

My Setup and Ground Rules

I will invest in 10 Non-dividend paying stocks that are initially contained within the S&P 500 index. If they are later dropped from the index I may sell and reallocate or do nothing. If they later decide to pay a dividend I will try and sell prior to the x-date and reallocate the cash to a new stock or the ones remaining. When I invest the cash into these 10 stocks, I will generally invest an equal dollar amount into each 10 using the features of a broker which allows this type of “dollar” investing instead of “share” investing. I may not always invest in all 10 at the same time if I view the valuations of some as higher than my cost basis. After all my goal is to make money and not just create a portfolio for fun! In the spreadsheet below I will show a scaled value of $100k. By the end of 2022, if not sooner, I will have fully invested the cash. For obvious tax reasons, I don’t want to put an index in this portfolio, but I may, however, put a fraction of the 2022 total in VOO in my Roth account to track along.

Starting Positions

Since I don’t have any more knowledge of the future than anyone else I am not going to try and convince anyone that these 10 stocks are going to perform any better than any others. Caveat emptor! However, early results are encouraging.

Below is an allocation by Sector:

Communication Services

Consumer Discretionary

  • Amazon (AMZN)
  • Chipotle Mexican Grill Inc (CMG)
  • Tesla (TSLA)

Financials

  • Berkshire Hathaway Inc (BRK.B)

Industrials

Information Technology

  • Salesforce Inc (CRM)
  • PayPal Holdings Inc (PYPL)

Below are the current standings as of 8/15/22

my spreadsheet of real data

My spreadsheet of real data

Most of the purchasing of stocks for the above was done between May 2nd and June 16th of this year. From now until the end of the year I will be equalizing the 10 positions and working down the cash position.

In future articles, once the portfolio is “locked in”, I will drill down into the individual stocks and the portfolio asset allocations.

Conclusion

It is important to understand how the total return of the investments you put in your retirement account affects your retirement and the money left over for your heirs. We also know that the total return is directly related to the income you can generate in retirement. The math tells us that the income will be the same for the same total return, whether you sell shares to generate it or get the income directly from dividends. If you want to see that math worked out here are two articles I wrote in 2019 demonstrating it, called Is There Magic in Dividends and A Dividend, What is it Good For.

Each person must understand their needs and be able to choose the strategy that best fits them. Just because something works for one person does not make it suitable for the next. Often money may be tight during retirement, and which strategy you choose can make a difference. However, if the strategy is volatile beyond your tolerance level, that in itself can sometimes make that strategy unsuitable for you.

You also must realize that past performance is no guarantee of the future, and in that regard, all the information presented here is past performance. The information provided here is for educational purposes only. It is not intended to replace your due diligence or professional financial advice.

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