I love the smell of dividends in the morning...
This post is a quick introduction to dividends with a focus on how they behave in Japan. There are several schools of thought on dividends and different people will want to approach them in different ways.
What are dividends?
Dividends are regular or irregular payments made by companies to their shareholders. It is a form of profit-sharing. Not all companies pay dividends. You can find dividend information by searching online for 'company name + dividend' or similar.
You can also use Yahoo Finance to find the information (Google Finance used to be good but for some reason they 'updated' it and now it's useless). If you are looking for Japanese stock information be sure to use Yahoo Finance Japan as the US site doesn't show dividend information for Japan-listed stocks for some reason.
What are the benefits of dividends?
The benefit of dividends is that they can provide regular passive income. As long as companies continue paying the dividend you don't have to do anything to maintain your income. Many companies increase their dividends over time, often at a rate greater than inflation. Investors don't have to sell their investments to get money.
A lot of the growth in the stock market comes from dividends as opposed to capital gains.
Dividend growth investing is a popular approach to investing and retirement that involves investing in stable, dividend-paying companies and holding for the long term. Here's an enthusiastic write-up from Jason Fieber (who used to write the website Dividend Mantra and is now Mr. Free at 33).
What are the drawbacks of dividends?
There are several. The first is that dividends are not guaranteed, and can be cut or even eliminated by companies.
Another is that dividends are tax-inefficient. If companies or funds reinvest dividends (or buy back stock) instead of paying out cash to investors those funds can grow tax-free. However if investors receive a dividend they will need to pay tax on it and over time their investments will probably grow more slowly.
If investors then want to reinvest the dividend, they may have to pay fees and other costs which could have been avoided if the money was reinvested internally.
People who focus on dividends will probably choose individual companies, which can produce worse results than just buying an index (which will also contain growth companies that may not pay a dividend).
How are dividends taxed in Japan?
Dividends are taxed at 20.315%. If you hold the shares or funds in a NISA account you will not pay tax on the dividends.
If you hold the shares or funds in a taxable account (特定口座) the tax will be deducted and paid by your broker, and you don't have to do anything else.
If you hold the shares in an ordinary account, you will have to declare and pay the tax yourself. This can be more expensive but may allow you to use deductions. I don't do this but perhaps any tax ninjas could explain this in the comments :)
This article in Japanese explains the various ways to deal with taxes on dividends.
If the shares or funds are listed in the US, the US government will take a 10% withholding tax (reduced rate for residents of Japan). You can deduct this from your Japanese taxes but will have to submit a tax return to do so. In a NISA account you cannot recover this US tax as there are no Japanese taxes to deduct it from.
What's the best approach?
From a mathematical perspective, it appears the following is true (there is a great thread on the forum about this that goes into a lot of detail):
The best way to invest may be to buy low-cost Japanese mutual funds that reinvest dividends within a diversified portfolio. This can be done with three funds: a developed world equity (ex-Japan) fund, a developing world equity fund, and a Japan fund. To match world markets, the proportions would be 80% developed, 12% developing, and 8% Japan. For many mutual funds you can choose to reinvest dividends when you buy them. This is usually called 「配当金再投資」 or something similar.
For foreign-domiciled ETFs, you can sometimes buy 'accumulation' versions which reinvest dividends as opposed to the 'distribution' ones that pay them out.
Reinvesting dividends is perhaps more likely to grow over time and investors that adopt it will probably end up with more money in the end.
However, dividend-focused investing has some psychological benefits. It's very encouraging to see your dividends arrive every month, especially if they grow over time. You can spend the money and it is very clear how much income you are receiving from your investments.
What do you do?
Well, I actually use both approaches. Most of my investments are in index funds but I also have a dividend-focused portfolio of individual companies. My goal is to have the dividends provide me with a basic income in the future. For now it contributes an ever-growing proportion of my NISA allocation each year.
How about you? Do you have a dividend strategy? What is your focus for investing?