Many investors are getting a special dividend treat in late 2012, and while that's exciting, it’s all about a changing tax picture.
And that means some investors are going to be faced with choices.
We generally hew to a buy, hold and rebalance sensibility here at IndexUniverse, so I’m not going to say that all these special dividends suggest the end is near or that dividend-focused ETFs ought to be avoided but, please, do be cautious and aware.
After all, tax issues are thorny, and should be taken seriously and thoughtfully—with professional advice.
As it stands, dividends are taxed at a rate of 15 percent, but if the U.S. were to lurch off the so-called "fiscal cliff" at the end of the year, the tax rate on those dividends could jump to as much as 40 percent.
One thing seems clear:Companies are looking to throw investors a bone by distributing many extra payouts either in the form of "special dividends" that were not previously scheduled or by shifting 2013 dividends into end-of-year 2012.
A total of 173 companies have announced special payouts this month—a 140 percent jump from November 2011—according to Howard Silverblatt, a senior index analyst at S'P Dow Jones Indices.
To take a step back, I think dividends are already unduly punished by the tax man, and it could get worse very soon.
As a shareholder in a company, you are a partial owner, and in turn you own a share of the earnings that the company produces. The company is taxed on those earnings, and if they choose to return your earnings to you—the owner of those earnings—they are taxed again. Good for Uncle Sam; bad for investors.
For investors who depend on dividends for cash flow, that tax risk is material and, as I was saying, they really ought to speak with a tax professional to formulate a new coping strategy.
The rest of us, I suppose, can enjoy the treat! The extra dividends or early payouts are an unexpected consequence of our dysfunctional Congress.
Don’t forget though, there’s no such thing as a free lunch:Unless the economic recovery gains some serious traction, dividend yields in general will almost certainly start shrinking in 2013. Just don’t be surprised when it happens.
There is, however, some hope for dividend yields in 2013.
The Wisdom Of Dividend ETFs
If you choose to stay the course in spite of the higher taxation rates that are almost surely coming up, know that some ETFs have consistently delivered bountiful dividend yields.
I mention diversified portfolios of dividend-rich stocks because it’s easy to be tempted by headlines that flaunt Costco’s $3 billion—$7 per share—payout.
Companies like Costco, Las Vegas Sands and Wynn Resorts all pushed their dividend yield from the 1-3 percent range to the 6-8 percent range for the year, after accounting for all their special dividends.
But don’t be hoodwinked.
Those looking for yield are better off in a dividend-focused ETF.
After all, several ETFs on the market produce comparable dividend yields to individual companies, and deliver payouts more consistently and across a broader holdings base.
State Street’s SPDR S'P International Dividend ETF (DWX), for example, has produced an outstanding average annual dividend yield since its 2008 inception—north of 7 percent.
For those with an emerging markets appetite, the SPDR S'P Emerging Markets Dividend ETF (EDIV) has yielded more than 6 percent over the previous 12 months.
But we needn’t reach so far as emerging markets for yield. Even a diversified basket of companies from developed countries can produce more stable and still-impressive dividend yields.
The iShares Dow Jones International Select Dividend Index Fund (IDV), whose assets are almost entirely in developed markets, has a dividend yield upward of 5 percent—consistently.
The point is that those companies announcing special dividends are unlikely to make such large distributions moving forward.
So, those undeterred by taxes are better off in any of a number of dividend-focused ETFs.
Again, that’s because they consistently produce strong dividend yields, are more diversified and draw dividends from a larger, broader pool of securities.
The takeaway is this:Enjoy the dividends in late 2012, but don’t be the kid who opens his Christmas presents a month early only to be disappointed in December.
There’s a price to be paid for "early" and "special" dividends, and that price will be in the form of inferior dividends in 2013.
And the only way to minimize this very real possibility is to preserve as much dividend yield as possible by owning diversified payout-focused funds.
At the time this article was written, the author had no positions in the securities mentioned. Contact Spencer Bogart at firstname.lastname@example.org.
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