More Benefits of the Dividend Lifestyle
From an expense standpoint, owning a basket of individual dividend payers and holding them for the long run, is about as cost-effective as you can get. As stated, the cost of ownership is super low because it doesn’t cost you anything to own a share of stock. There’s no internal expense like with a mutual fund or other packaged product because there’s no middle man. It’s just you. If you work with an advisor, the only expense you would have is the advisory fee. If you do it yourself with no advisor, then you may have a small trading cost when you make the initial purchase of the stock, but there would be no expenses moving forward, again, no middle man. For the fee-conscious investor, the Dividend Lifestyle may be a good solution to consider. A mutual fund, on the other hand, will have internal expenses on the fund both up front, on-going, and sometimes on the back end when you sell. A fund manager is buying and selling in the fund on-going, and they have to get paid. There’s a research team with benefits and health insurance, technology, trading costs, marketing departments, and they have to print your statements. Welcome to the world of mutual fund expenses. Money is constantly being taken out of the fund, which is dragging on the fund’s performance.
With mutual funds and other registered Wall Street products, you have an array of expenses that you are paying, and the worst part is most investors do not understand the total cost of ownership. Sure, you can find it somewhere buried deep in the prospectus on page 193, but who has the time or attention span (remember the gold fish) to read the fine print. The fund companies love fine print, and they pay their teams of securities lawyers handsomely to provide you with the bare minimum in terms of transparency allowed under the law. You practically need a Fiduciary to analyze the fund and give you an X-ray report to understand the total cost of ownership of the fund. I have seen mutual funds with expense ratios of 4% and 5%! No wonder the fund is underperforming the market. You have to make 5% to break even each year.
So, what kinds of expenses do mutual fund companies charge? Well, let’s start with commissions. Depending on the share class, the advisor who sells the product can earn an upfront sales charge. A-share mutual funds carry this type of expense, and they are as high as 5%, meaning you invest $100,000, and only $95,000 shows up in your account on day one as the $5,000 commission was taken right off the top. Ouch. Next, you have 12b-1 fees. These are generally 1% and are paid out annually to the advisor who sold the fund. You don’t see the fee coming out as you would with a fee-based advisory relationship, but it’s there and is being taken out over the course of the year. Then we have deferred sales charges that are popular with B-shares. This means that if you sell the fund within the first few years, you pay a back-end sales charge. This is also very common with annuities. However, the insurance companies call them surrender charges. Finally, we have mortality and expense fees which are generally found in annuities and other insurance products and can range from 1%-2% annually. When you start to add them up, it can severely impact your returns over time. With dividend-paying stocks, there’s no middleman, no internal expenses, and no ongoing cost of ownership. It’s you and the stock. And if you work with an advisor, you would pay the advisor an agreed upon fee for advice, potentially resulting in a much more cost-effective option than using mutual funds.
There are great tax benefits to living the Dividend Lifestyle. It’s incredibly tax-friendly, especially in brokerage accounts. The only tax you pay is on the dividends, and that is treated as ordinary income. Depending on your tax bracket, it could be anywhere from 0% if you have very little income to show, have a lot of deductions, or have a good CPA. If the effective tax bracket for a retiree is 10%, you owe 10% on the dividends. If it’s zero, you owe zero. If it’s 35, you owe 35. Regardless of what you do with those dividends, take them out as income or reinvest them; there’s no capital gains tax unless you decide to sell something for a gain.
Unlike a mutual fund, you’re in the driver’s seat regarding capital gains and capital losses. You have control over the companies you own. You can utilize tax-loss harvesting, which is very attractive from a tax reduction standpoint. With the Dividend Lifestyle, you can pick and choose at the end of each year, go through your list and say, “Okay, do I have any stocks that are down for the year?” If you do, you can sell them and realize the capital loss, which can be used to offset capital gains with no limit, and it can be used to offset ordinary income up to $3,000 per year. Whatever you don’t use, you can roll forward indefinitely to be used to offset future gains and income.
The compliance folks will make me say, Please consult your tax attorney or CPA. I am not a CPA and cannot give direct tax advice, you know the drill, but the tax loss harvesting is beautiful because we do this every year for our clients, and we work closely with their CPAs. We go through the list, and if a stock is down, we will sell it and realize a cap loss. That’s free money. Then we can turn around the same day and buy something as long as it’s not the identical security. Then we can turn around the same day and buy something new, so long as it’s not the identical security. If you really want to buy back the identical security, you can do that too. You can realize the tax loss when you sell, but you have to wait 31 days to buy the same stock back. This is called the “30-day wash rule,” and it’s a major advantage of the Dividend Lifestyle.
This is a big opportunity for an investor coming out of mutual funds. Something they’re not getting now. You can tell me the name of any mutual fund, we can easily research the fund, and we can look at what the capital gain distributions were every year going back as far as the fund has been around. Whether the fund made money or lost money that year, you could be paying taxes on any gains that that fund manager realized. That doesn’t happen when you own the individual securities.
Once an investor has these concepts, it’s fun to pass on that knowledge and wisdom to the next generations, like Grandpa Fred did. But when it comes to generational wealth, there are not just financial assets to be passed down. When I ask folks what they think about when they hear the word “asset”, almost every time they tell me they think of something financial-stocks, bonds, cash and real estate. But there are other forms of assets, some of which are many times more valuable than financial things. They talk about this in my coaching program, Strategic Coach. In addition to financial assets, there are also human assets, which are your community, family, faith, values, and relationships. Then you have the intellectual assets, which are your education, experiences (both good and bad), wisdom, knowledge, and health.
If you have these three different assets, financial, human, and intellectual, and you could pick only two of those groups to pass on to the next generation, which two would you pick? Every single time, people pick the human and the intellectual. They never pick the financial. The answer is always, “Well, yeah, I want them to understand our family traditions and our moral compass. I want them to value their health, the way they treat people and to have a good education”. Personally, that’s the most important thing I want my son Chance to understand because if he has that, he can find the financial assets and build them on his own. If you only give the next generation the financial assets and don’t pass on the intellectual assets or the human assets to go with it, they’re doomed because they’re not going to understand how to manage the money.