The income obsession

unrecognizable man holding wallet with money

If you read finance theory, an asset returns two kinds of returns. One comes from dividends, interest or rent that the asset pays. The other comes from the appreciation of the price itself. What do I mean?

Since 1st march 2021, TCS has increased in price from about 2950 rs to about 3550 rs. That is the price appreciation part. TCS has also paid 36rs of dividend in the same period. So an investor has made a total return of 22%. That is not a bad return.

TCS is just an example. There are other stocks. REC LTD has gone from 135 to 125 in the same period. A loss of 10 rs. It has also paid out 17.21 in dividends. Total return here? Just 5%.

Comparing two stocks, you could have bought 22 shares of REC LTD for the price of one TCS share. That would have given you a nice dividend of 379rs. The dividend is 10 times more than what TCS paid but still, the overall return is just a quarter of what TCS gave over the same period.

Many people prefer dividend investing. Dividend investing is where one picks stocks that pay out high dividends. There are several problems with it. Many companies pay dividends at the cost of growth. Those that pay dividends upwards of 5% usually do not appreciate too much in price. But still, because dividends are credited in the bank account, it feels like you have made more tangible returns than just some green numbers on the screen.

There are some disadvantages to this cash in the bank though, First, dividends are taxed higher than capital gains. Second, companies paying dividends are not the most efficient capital allocators, at least in India. As a result, dividends are the only reason many shareholders buy and hold those stocks. Even a year of low dividend distribution can send the stock spiralling downwards as the investors will look for returns elsewhere. Third, most of these companies fall under the same peer group, viz. government-owned, commodity or power businesses. That adds concentration risk to the portfolio.

A much better option would be to systematically sell part of your portfolio to meet your income needs. There are ways to do it. Simplest would be to move part of your portfolio in fixed income every year and eventually withdraw it when you need money. Maybe we can discuss it in another article. But as is the name, it is called personal finance. So find what works best for you.