Weekend Reading: Money Makes Money (Sort Of) Edition
I read a Globe and Mail piece by RBC senior portfolio manager Nancy Woods this week, one of those “investing basics” explainers aimed at people just getting started.
The hook was a herd-of-cows analogy: your money is the herd, dividends are the milk, price appreciation is the baby cows (the herd growing over time). The more cows you have, the more milk, the more calves, and so on.
Woods concludes: “Money makes money.” It's a folksy and memorable framing, but it's wrong in at least one critical way.
The analogy frames dividends as something a company produces for you, like actual milk from an actual cow. But that's not how dividends work. Dividends aren't milk. It's just moving money from one pocket to another.
When a company pays a $1 dividend, the share price drops by approximately $1 on the ex-dividend date. This isn't a coincidence or a market quirk, it's basic arithmetic:
The company just sent cash out the door, so it's worth less. You now have a slightly smaller investment and a bit of cash in your hand, with a net change in wealth of zero, except now you owe tax on that cash (if held in a taxable account).
The cow didn't produce milk out of thin air. She just transferred some of her own body weight into a bucket.
So what is the analogy actually describing?
Total return, which is the combination of price appreciation and income. And total return doesn't care whether your gains come as dividends or share price growth.
A stock that pays no dividend but grows 8% annually gives you the same outcome as one that pays a 3% dividend and grows 5%, before tax.
In fact, you come out ahead with the non-dividend payer because you control when you realize the gain, a concept economists call a “homemade dividend.”
If you need income, sell a few shares. You end up in the same place as the dividend investor, but on your own schedule and with potentially better tax outcomes.
The real insight buried in here
Woods isn't entirely wrong, she's just wrong about the mechanism. The genuine principle underneath the cow analogy is that you shouldn't erode your capital base faster than your portfolio is growing. That's true whether you're spending dividends or selling shares.
Where the analogy misleads people is in suggesting that dividend-paying stocks are inherently safer or more productive than growth stocks, when in reality a company paying a generous dividend isn't giving you anything extra.
The company is simply paying out a portion of its earnings as cash instead of reinvesting them, and you're paying tax on it (if held in a taxable account) whether you needed the money or not.
None of this is to say that Woods is wrong to encourage people to start investing, and using a relatable analogy to get someone off the sidelines is a worthy goal. But oversimplified mental models have a way of hardening into dogma.
The dividend investing community is full of people who treat dividend income as “free” money, like eggs from a chicken or milk from a cow, while viewing their principal as something sacred and untouchable.
In reality, a dollar of dividends and a dollar of capital gains are the same dollar, just arriving by different routes and often with different tax consequences.
When investors lose sight of that, they can end up chasing yield, overweighting income-heavy sectors, and ignoring total return, all because a metaphor made dividends feel like free money.
The cows aren't sacred, and the milk isn't magic. They work together as part of your total return.
This Week's Recap:
I'm officially a British citizen with a British passport! That's good news and good timing, because due to the UK's ETA system rollout British citizens can no longer use foreign passports to enter the UK – and we have a trip to Scotland booked for early July.
Earlier I explained how to do a better job estimating your taxes so you're not surprised at tax time.
And then I opened up the “Money Bag” to answer your questions about CAGE, cash wedges, and net worth calculations.
Weekend Reading:
Why the years just before and after retirement are especially vulnerable, and what investors can do to reduce sequence‑of‑returns risk.
For some retirees, underspending their retirement savings is a bigger problem than overspending. 100% agree.
Anita Bruinsma shares the five golden rules for investing.
Nick Maggiulli explains why survival is the only success:
“It doesn’t matter what you do in life if you can’t sustain it. You could make $100 million, but if you end up in a prison cell or broke, who cares? That’s not success. In fact, it’s the opposite.”
Here's Jason Heath on why retirees are often shocked by tax bills and how to reduce them.
The most important video Ben Felix will ever make: Using your money to be happier:
Want to be a landlord? Make sure you know the tax rules.
When Canadians lose a parent from afar, managing the estate can get complicated.
Here's what you need to know before passing property to your adult children:
“The biggest mistake families make is focusing on saving a few thousand dollars in probate fees while accidentally creating tens of thousands in tax and legal problems and potential family issues.”
Finally, what’s the ideal age to downsize? Wait too long and ‘your doctor, your lawyer or your kids’ will decide.
Have a great weekend, everyone!
Woods has an obvious conflict of interest here. “Dividend investors” buy “blue chip” RBC sock. Index investors do too but far less.
What Woods didn’t disclose (but should have) is that she personally benefits from misconceptions promoted in her article because her compensation likely includes:
* bonuses tied to business performance,
* deferred share units (DSUs),
* restricted share units (RSUs),
* stock options or performance share units,
* mandatory share ownership requirements for senior staff.
Well said, Robb. Nuance is important!
I thought many companies paid dividends from annual profits, thereby leaving the value of the company the same, not lower. Maybe this is one of those misconceptions amateur investors have?
If D dollars stay within the company (eg via being invested) then the value of company is A dollars.
If D is paid out as dividends then the residual value is A – D. You can see it when share price drops on ex div days. Masked a little by normal stock fluctuations but statistically the effect is obvious.
Whether it makes sense to pay dividends to maximize investor profits depends on how effectively a company can invest the funds,
As Mordko said, when you receive $1 in dividend, the following changes occur in the company`s balance sheet:
$1 is taken from assets (liquidity) and, to balance it, $1 is taken rom the BOOK value of the shares (shareholders equity). This is the accounting side of things.
However, there is no correlation between the market value and the book value of a share. The share price can go anywhere on the ex-dividend date or the pay date.
There is positive correlation between the book value and the market value. Fama and French demonstrated it among others https://www.ivey.uwo.ca/media/3775516/size_and_book-to-market_factors.pdf
Similarly, while masked by market fluctuations, on ex-dividend date, the stock normally adjusts downward by about the dividend amount because new buyers no longer receive that dividend. Schwab states this directly: the price is typically reduced to reflect the dividend paid to the seller https://www.schwab.com/learn/story/ex-dividend-dates-understanding-dividend-risk
Pay date is irrelevant in this context.
The Fama and French study assumed the following: “If stocks are priced rationally, …”
We know they are not. See for example Tesla market value being higher than all other car manufacturers combined, without the revenue and earnings to deserve it.
Stock prices can be affected by fashion effect (“meme stock”, FOMO) or irrealistic expectations for future growth.
That study is also based on data from 1991, before discount brokerage was easily available.
The Schwab article is about call options, which is basically gambling.
A particular stock can be priced irrationally. That is not the same thing as “ there is no correlation between the market value and the book value of a share.”
If that is indeed what you believe then all investing = gambling. You shouldn’t be invested if thats your opinion. But its wrong.
Full marks for opening the links but you have to read and understand to comment. The Fama article is still the fundamental theory behind stockmarket regardless of discount brokers. In the Schwab article the options discussion is irrelevant to the underlying point. The article explicitly describes the standard stock-market mechanism for ordinary shares:
“On the ex-dividend date, the stock price is usually reduced by the amount of the dividend.”
You can also read this if you have time: https://www.sciencedirect.com/science/article/pii/S0304405X9700041X
They are analyzing stats, and dividend taxation introduces slight distortion but the basic rule fundamentally stands in the real world. Not for necessity for a particular stock on a given day but for a large number of stocks over time. And positive correlation is a fact; its not a matter of opinion.
I’m a long term investor with some stocks held for 30+ years. I am 100% equities.
I never said that investing = gambling, I said that options = gambling, expecially for the small investor.
Your latest study explains how arbitraging works on ex-date and how they make their trading decisions (during the very short window after markets open) but doesn’t contradict what I said.
The share price after market opening can go anywhere, even lower than the dividend difference or higher. Its book value remain the same, hence my statement about the lack of correlation.
You don’t understand “correlation”. Positive correlation does not preclude price fluctuations. Key statement: “The expected price drop is strictly less than the dividend but within one tick of the dividend.” The empirical/market microstructure point is that on the ex-dividend date, the share price does not move randomly relative to the dividend. On average, it drops by an amount close to the dividend. And that means correlation, see dictionary.
I won’t lose any more time with you explaining the difference between book price and market price.
The correlation is on book price, not market price. The market price doesn’t care that the opening price was previous close price – dividend + tick. It starts diverging only a few microseconds after market opening.
If you had a study showing what is the CLOSE price on ex-dividend date and the following days and constantly demonstrate a decrease in a stock MARKET price, then you would have some kind of argument.
This is not about book price. The study measures actual market-price changes around the ex-div date. Bali & Hite’s paper is explicitly about “observed ex dividend day stock price changes” and why market prices decline by smidgen less than the dividend.
You don’t understand what you are reading.
The Dunning-Kruger effect is strong with this one…
Let’s look at a recent dividend payment and what happened to the MARKET stock price:
Apple (AAPL), ex-dividend on May 11th, $.27/Quarter, $1.08/Year
As an ordinary individual investor, I only have access to market data between 9h30 AM and 4h30 PM daily.
May 8th close: 293.32
May 11th opening: 292.13
Ex-dividend date. The opening price dropped (expected) by more than 4 times the quarterly dividend, far below what is supposed to be the normal drop. The BOOK share price dropped by the dividend amount.
May 11th close: 292.68
The drop was reduced to about twice the quarterly dividend, still below what is supposed to be the normal drop.
May 12th opening: 293.27
We are almost back to the price before ex-dividend due to May 11th after market and May 12th before market trades.
May 12th close: 294.65
We are up by .34% and the BOOK price didn’t change from the day before.
May 13th opening: 293.94
May 13th close: 298.85
We are up by 1.7% and the BOOK price didn’t change from the day before.
May 14th opening: 300.17
May 14th close: 297.87
Some profits taken, but still 1.36% up, and the BOOK price still didn’t change.
May 15th opening: 297.90
May 15th close: 300.23
Week gain is over 2.35%, and the BOOK price remains the same as on May 11th.
In short: the MARKET value doesn’t care about the BOOK/ACCOUNTING value.
“The market can remain irrational for longer than you can be solvent”.
The key mistake is pretending that if dividends affect price, then the opening price must equal: 293.32 − 0.27 exactly.
Markets do not work that way. Stocks move continuously due to many factors simultaneously.
The empirical finance literature is extremely clear on this point: on average, stocks drop by approximately the dividend amount on the ex-dividend date.
Please look up “average” in the dictionary. If a company issues bad earnings guidance the same night it goes ex-dividend, the stock could open down $10. That would not mean the dividend had “no effect.” It means multiple effects occurred together.
This is like talking to someone who never did even the most basic stats at school. Suppose someone says “in May average temperatures increase by 10°C.” You are the kind of guy who would say: “Nonsense. Yesterday the temperature dropped 3°C overnight and the day before it only went up 5C.”
Looks like reading comprehension is not your forte…
You keep building strawmen while not addressing my statement that the market doesn’t give a “censored” about what share values were in the first microseconds of market opening on ex-dividend date.
I invite you to look at the first graph of the following article:
https://understandinginnovation.blog/2015/07/03/the-dunning-kruger-effect-in-innovation/
I am somewhere between point 2 and 3, knowing that I still have a lot of things to learn, while you are anchored at point 1.
You’re absolutely correct Rob. But I like our eligible dividends in our non-registered account and our TFSA,s. In our RSP’s and RIFF’s we opt for capital gains. Before we shut our company down we were getting most of our income from eligible dividends from our company investment account and we didn’t pay a lot of tax for the amount of income.
Now we still get a lot of our income from eligible dividends, along with CPP and RIFFS.
And the dividend tax credit still helps us. We both take a healthy income and our combined overall tax rate is just a little over 10%.
Maybe I’m looking at this wrong but in my mind it works the best for us. The dividends keep growing, we haven’t used any capital in the non-registered account. The income in the TFSA’s hasn’t been touched yet, but is there if needed for an emergency. They can be used to pay tax in the end.
Hi Pete, there are certainly worse strategies than holding Canadian dividend paying stocks in your non-registered account. The only thing I’d be mindful of is how dividends impact the OAS clawback. The calculation for clawback purposes is taken *before* the dividend tax credit (the grossed-up amount) and so targeting high dividends in a taxable account can have a significantly negative impact on OAS if the gross-up pushes your taxable income above the clawback threshold.
Yes it does and we are being clawed back but, from what the accountant saws we’re a little ahead with the dividends. If we need extra cash now we’ll take out of TFSA and put back when we have to take more from our RSP’s when we have to convert them. We’re not going to stress or worry about the clawback.
We look at it this way. The overall tax bill, taking into account the clawback now might add another 1 1/5 to 2% to it, if that makes sense.
What I’ve noticed is that most of the retirement income calculators don’t do a very good job of taking into account actual tax that we pay in this situation. They show us paying a lot more tax than we do.
A comparison might be a good topic.
Many thanks, much appreciate your insight 😊
Accountants tend to be focused on taxes. Rightly so but its not the whole picture to figure out if one is “ahead”.
We have both Canadian and US stocks in our non-reg, as well as some international ones. Right now its 41% VTI.
Over the last 10 years total return for Canadian stocks doubled the value while US tripled. I have not done a full calculation accounting for the impact of capital gains and dividend taxes but we benefited by keeping non-reg account diversified rather than focusing on Canadian divs. And I think we did this while having less risk and volatility.
Its a complex story but I am trying not to focus on taxation when it hurts diversification. For one thing, Canadian companies pay high taxes on profits which comes out of our returns even if we don’t see it in personal tax returns.
Quick back of the envelope calculation, ignoring the impact of returns and diversification on portfolio and focusing on cap gains vs eligible divs:
Assuming:
* Ontario resident,
* both spouses already at about $100k net income each,
* into OAS clawback territory,
* comparing an additional $1,000 of:
* eligible dividends vs.
* realized capital gains.
$1,000 eligible dividend costs circa $290 in tax and OAS.
$1,000 cap gain costs $210 in tax and OAS.
The average tax on total income is still low but I don’t think eligible divs are quite as tax efficient as people seem to think – unless your income level is quite low.
Great article Robb and congratulations on getting your British Passport! I got my Irish Passport 🙂
I don’t want to make a comment, but I do have a question. In previous news letters you have promoted both Wealthsimple and VEQT. My question. I have a LIRA being managed by Sunlife, management fees are high, and returns are low. I am 15 years away from retirement, would you endorse transferring the assets to Wealthsimple and investing in Vanguard ETFs?
Hi Barry, thanks for this. I can’t say whether that’s a good idea for you, specifically, without knowing your financial situation and capacity to manage your own investments.
I will say, in general, that if you understand that investing has largely been solved with low cost index funds, and that investing complexity has been solved with an asset allocation ETF, and you’re comfortable in a portfolio of 100% global stocks (knowing that the higher highs come with lower lows from time-to-time), and you can stay in your seat and not tinker when markets are misbehaving, then I think you can do well moving from high fee mutual funds and into a global stock ETF.
I like and use Wealthsimple, but any online broker will do the trick.
Thanks so much for your speedy response. I will move forward by opening an account with Wealthsimple, transfer assets, and purchase one or more global stock ETF. Mutual funds are not immuned to market gyrations, and their MERs take a significant bite out of the returns. Thanks again for your response
I have been a dividend investor for about 10 years, and have read that part of the benefit of dividend paying stocks is that the management of dividend paying companies is somewhat “tighter”/less volatile, knowing they are constantly having to manage dividend payouts and shareholder expectations. Possibly this is confounded by the types of companies that tend to be dividend payers, usually being in less volatile industries.,
I’d love to hear some comments from all of you very well read and experienced investors on this aspect.
I believe in equities but am also somewhat risk averse, and have felt that dividend stocks are my “happy medium”, although I do see the point that in non-reg accounts yearly taxes eat away at your profits earlier than if you “let the gains ride” on stocks that don’t pay dividends…
Its a poor indicator of management quality. General Electric, AT&T, Kraft, Boing – all paid divs while badly managed. BRK and AMZ don’t pay divs but are pretty safe and well managed.
Dividends are correlated with “Value”, but again… Not a good indicator, we have far better ones.
The real problem with this strategy is that its a fairly random criterion but its also closely tied to a small subset of industries. So, by using it you are reducing diversification and hence increasing your risk.