Last December I wrote about how much I appreciate us receiving dividends with our investments. Since then I have encountered an unsettling fact: apparently, dividends are not the “free money” I thought they were 🙁
As it turns out, when one receives dividends from stocks (or from stock index funds, as we own), the price of that stock drops by the same amount as the dividend!* In other words, while it is true that reinvested dividends yield more ownership (when the dividends are used to simply buy more shares), this literally comes at a cost of the price of the stock or fund.
Let’s take a real example. I’m about to receive a dividend for VGSLX, the Vanguard US Real Estate Fund. Today VGSLX dropped by 0.99%. However, the ETF equivalent fund, VNQ, went up by 0.14%. These are basically equivalent funds. Why the discrepancy of over 1% in performance? It’s because the price of VGSLX was adjusted by the amount of its dividend.
I expect that when I look at the dividend tomorrow, it will be for the equivalent amount of the 1.13% total drop (the difference between the 0.99% it fell and the 0.14% it would have risen had today not been a dividend day) the fund experienced today.
As the Chicago Booth Review explains in “Dividends Are Not Free Money (Though Lots of Investors Seem to Think They Are)”:
A $1 dividend from a share of stock should be no more meaningful than selling $1 worth of shares, as the share price on average drops by the amount of the dividend when it is paid.
It’s a little like realizing the toys you received for your birthday came from your bedroom closet.
Don’t get me wrong. It is still preferable to receive dividends, and especially then to reinvest them.
Yet… fie, Dividends. Fie! How the truth hurts!
*Apparently this is not true for bonds. But then, bonds don’t pay dividends–they pay interest payments.