The Dangerous Illusion of ‘Free Money’ as An Investor (2024)

The rational investor cares about one thing; total investment returns.

Total returns for stock market investors = capital gains + dividends — investment fees & taxes

All that matters is, what is my account balance? If you have a $100,000 portfolio, the $100,000 is all we should care about. We shouldn’t care whether that $100,000 came from dividends or capital gains (increase in share prices).

Except we do care. We care a lot.

A 2021 paper titled “consuming dividends” written by Konstantin Bräuer (University of Frankfurt), Andreas Hackethal (University of Frankfurt), and Tobin Hanspal (Vienna University) examined why investors are drawn to dividend-paying stocks and how some investors plan their entire financial life around dividends.

The Researchers used bank data, portfolio data, and survey data to measure how investors’ spending habits changed around days of receiving dividend income from a portfolio. Their findings show that many investors allowed their spending to be dictated by the dividend policies of the companies they invest in.

Finding #1: Investors are significantly more comfortable spending dividends than their paycheck.

• 14.4% of dividends an investor receives are spent on one-off purchases within a week. The majority of that spending occurred on the day they received the dividend.
• Only 9.6% of labor income was spent on similar purchases within the same period.

Finding #2: Dividend bias exists for the young & old and the rich & not-so-rich.

• Increased consumption around dividend payments is significant across wealth and age distributions.

Finding #3: Supersavers are the most reliant on dividends to fuel their spending

• Past research has suggested that those who rely on dividends lack self-control in their spending habits.
• This study finds the opposite result; “those who would prefer to save rather than spend, consume a larger fraction of…