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Whittling Down the Worries Over Likely Dividend Tax Increase


For more than 50 years, Mad magazine's red-headed mascot, Alfred E. Neuman, has enjoyed iconic status and his own signature saying: "What, me worry?" While many people are fretting over the harmful possibilities of our looming fiscal crash, there are those who are taking the other side of that fear trade and embracing a more Neuman-esque approach, particularly as it pertains to possible changes to the tax code and to dividends.

Certainly the weak stock market lately has made the appeal of dividends and the softening effect of their yields a favorite hiding spot for investors, but it has also given rise to calls that this "safer-haven," if you will, has become overcrowded — or even a bubble.

"I think dividend stocks are not as expensive as some are making them out to be," says Jeremy Schwartz, the Director of Research at WisdomTree, in the attached video. "What is important to do, is to always come back to what the underlying value is for these companies," particularly within the four key dividend paying sectors, including the Staples, Health Care, Utilities and Telecom.

He admits that a lot people are not only afraid of facing higher taxes on their dividends, but they are also worried that the broader markets could get caught up in any retreat. However, he says there are a lot of mitigating factors that will lessen the impact and keep declines in check.

"Not everyone is going to face the [tax] increase," Schwartz says, citing research that shows only half of dividends went to households making more than $250,000 a year, and then a large portion of these people have their yield plays in tax-insensitive or tax-advantaged accounts, such as an IRA or some other form of pension fund.

In fact, Schwartz says, if the President's proposed tax increase actually takes effect, it could have a more noticeable impact on the companies themselves, particularly their boards and management, in that it would make them more likely to do share buybacks and less likely to raise payouts.

And he's not alone in his defense of dividends. Miller Tabak economic strategist and Friend of Breakout Andrew Wilkinson writes to clients today; "Last week's market sell-off reminds us to be aware that stocks have the potential to quickly fritter healthy year-to-date gains over fears for a change in the treatment of capital gains and dividend payments. Yet we doubt that the worst case scenario for the US economy will come to fruition". In fact, his defense of dividend-payers doesn't stop there as he also suggests, "selling puts on dividend stocks might be one option for investors adopting the same thought process".

To be fair, a 2.5% dividend may seem nice compared with a 10-year Treasury yielding 1.6%, but it only takes a few bad days — such as the last week — to more than erase a years worth of expected income.

Still, Schwartz says his studies have shown the inflation-hedging value of rising dividend payouts cannot be overlooked either, as these cash payouts from companies often outpace more modest gains in the Consumer Price Index (CPI).

In short, Schwartz says, "there's a lot of these mitigating factors that would say there will still be continued support for dividend stocks."