The golden rule for young investors: if you want to be wealthier, ditch dividends

Young investor
Young investor

Think of dividends and you’ll likely think of reliable payouts from solid blue-chip FTSE 100 companies.

Maybe your grandfather gets a quarterly payout from Shell (“never sell Shell”, or so they say) or a handsome six-monthly cheque from Tesco – companies that have reliably stable business models backed by strong cash flows.

The issue here is that there is a big difference in payouts for an investor in their twilight years who typically has a larger portfolio than a 30-something millennial. And here’s the danger: what is good for the goose may also be good for the gander – but it’s certainly not good for the goslings.

Dividend investing has become popular with younger investors, judging by the amount of dividend investing YouTube channels there are being hosted by young people.

And while I am reluctant to say anything that may deter anyone from investing in their future, a dividend from Starbucks that doesn’t even buy you one of its coffees each year is not going to help you retire early.

It’s no secret that investing goals change over time. Someone who has built wealth and wishes to preserve and draw down from it is unlikely to be putting the bulk of that money in volatile growth stocks.

But someone with the advantage of potentially having a long time ahead in the market can afford to take on extra risk, because not only do they have the time to replace any losses, but they may also be able to ride out volatility better.

Selling your shares in a bear market because you need the money will not only leave a sour taste in the mouth, but could leave you financially worse off.

Now, am I saying young people should be steaming into speculative pharmaceutical drug development companies and high-risk oil exploration drills? Absolutely not.

Binary plays are for morons and gamblers – but companies that use that money to further their own growth can compound and generate attractive returns over time.

Indeed, investment firm Schroders found that of the 1,095 stocks studied that had a minimum market capitalisation of £150m there were 59 “30-baggers” (stocks that go up 30x) in the 30 years leading up to 31 December 2022. That’s 5.4pc against the US’s 4.2pc.

Obviously, these figures could be window-dressed to suit Schroders’ agenda, but Nick Train found in 2019 that since 1980, 12 of the then-FTSE 350 had 100-bagged. A further 65 companies went up 20-50x in the same period.

I’m not for one moment suggesting that finding and holding companies that go up by these amounts is easy – it isn’t.

Amazon fell 90pc at one point and has repeatedly almost halved since its initial price offering (IPO). But you only need one multibagger to make a lifetime hobby of investing worthwhile.

And to do that you need time – something which younger investors have in abundance. Squandering this in favour of playing it safe achieving mediocre dividends can be detrimental to your future wealth.

Furthermore, dividend stocks as well as growth stocks are not immune to market downturns. A healthy dividend should be covered multiple times by operational cash flow, but should that cash flow be hit then dividends are an easy way of shoring up the business’s finances.

This does, of course, hit the share price, which can then mean the value of your shares falls along with the dividend cut.

Now, it would be remiss of me not to admit that there are companies out there with progressive dividend policies that, over time, can eventually pay out more than the original cost of the shares (Games Workshop being an example). But these are rare, and true wealth comes from focusing on capital growth.

Not to mention the fact that dividend reinvestment can be tricky. If a company offers a Dividend Reinvestment Plan (DRIP) then this is simple – your dividends are automatically reinvested into the company by acquiring more shares.

But if not – and DRIPs aren’t common in smaller companies – then you can end up with a dividend that can easily see a good chunk of it disappear in dealing charges, depending on which broker you deal with.

If you get a dividend of £100 and have to pay £10 in broker commission to buy more shares, then you’ve paid 10pc in fees. Those fees add up over time and hurt your overall performance.

Dividend investing may be an art as well as a science, but here’s a rule you can stick to: If you want to be wealthier, ditch the dividends.

Michael Taylor is a professional trader and founder of shiftingshares.com