What you need to know before you start dividend investing

Getting a dividend feels like a gift. But who is paying for it? Discover why dividends can be both a blessing and a curse.

Back in 1610, the Dutch East India Company was the first company in the world to distribute dividends on its shares. Companies use dividends to share some of their profits with their shareholders. Historically, dividends have therefore been an important part of investors' total return.

Since 1930, 4% of the average annual return in the S&P 500 has come from dividends, in addition to the growth of the share prices themselves (6.08%). In recent years, this dividend flow has dried up somewhat. Today, an S&P 500 distribution tracker such as the iShares Core S&P 500 UCITS ETF USD (Dist) allows you to achieve a gross dividend yield of just 1% (as at December 2024).

In Europe, the average annual dividend yield is traditionally higher than in the US. A STOXX Europe 600 tracker such as the iShares STOXX Europe 600 UCITS ETF (Dist) currently allows you to achieve a gross dividend yield of around 2.75% (as at December 2024). From Proximus to Cofinimmo, Elia and Colruyt: there are also many dividend shares to be found on the Belgian stock market.

The reason for the difference between Europe and the US is quite simple. In recent decades, companies in the US have tended to use their profits to buy back and destroy their own shares to add value for shareholders. Tech companies are also becoming an increasingly dominant component of the US stock market indices. Many of these (growth) companies distribute no dividends or only limited dividends.

The sense and nonsense of dividends

Dividends may seem like a nice source of additional income at first but not everyone is a fan. It is still a subject that many investors disagree on, and for good reason.

On the one hand, dividends have clear benefits. When big names such as Meta Platforms and Alphabet distributed a dividend for the first time in 2024, this was praised as a positive step, a sign of maturity. The same goes for news reports of dividend increases, which are often seen as a sign of financial health and increasing profitability. A dividend growth strategy – investing in companies that systematically increase their dividends – appeals to many investors. In addition, dividend shares are often seen as a defensive investment, especially in times of economic uncertainty.

On the other hand, there are also critical voices. Dividends are sometimes seen as an inefficient way for companies to return capital to their shareholders, capital that should be reinvested or accumulated for more difficult times ahead. And because dividends are taxed, some investors prefer companies to keep that money and put it to work for them.

These mixed messages mean that investors don't always know what to do as far as dividends are concerned. Are they a stable source of income and a sign of sound management? Or an inefficient way to add value for shareholders?

What to look out for as a dividend investor

If you are already a dividend investor or would like to invest more in dividend shares, make sure to bear in mind these risks and points to consider:

1. The dividend trap

A common misconception is that dividends are an additional gain on top of a share's price gain. This is called the dividend trap. When a company distributes a dividend, the stock price tends to be adjusted by the distributed amount. This means that although you received a dividend, the value of your share decreases by a similar amount. The total return therefore remains the same. Some investors, however, think that the dividend is more like a bonus.

Another misconception is that dividend-paying shares are always less volatile due to the regular distributions. Although dividend-paying companies are often stable and mature companies, they are still affected by market fluctuations. It is the usually more defensive nature of the companies issuing these shares that dampens volatility, not the dividend itself.

2. Dividend traps: too good to be true

High dividend yields may initially seem attractive but they can also be a warning signal, particularly if you only look at the dividend yield. If company A offers a 4% dividend yield, and company B offers a 7% dividend yield, the next logical step seems to be that you go for company B. It can indeed be a better purchase but it can also be a dividend trap.

An extremely high dividend yield is often achieved when a company’s share price has fallen sharply. This is often an indication of fundamental problems, such as declining revenues or operational challenges. Some companies even use all their distributable profits to pay dividends, which leaves very little room for contingencies. Investors who rely blindly on a high dividend yield run the risk of falling into a dividend trap.

These dividend traps may ultimately lead to dividend cuts or even cancellations, which will further push down the share price. It is therefore crucial to look beyond dividend yields and always consider the bigger picture. Investigate the company's health, the stability of the sector and the sustainability of the dividend strategy. A healthy balance between efficiency and quality is essential.

3. Overconcentration in certain sectors

The ultimate objective of investing is to maximise the total return, which consists of capital gains and possible dividends. However, too much focus on dividends may lead to missed opportunities in sectors with high growth potential. Tech companies often pay little or no dividends but offer significant value growth. The strong growth of such companies, which (for a long time) were not distributing any dividends, has been the driving force behind the returns of broader markets in recent years. Investors focusing exclusively on dividends run the risk of missing out on value creation in such sectors.

Focusing too much on dividend income may mean that through overconcentration of investors' portfolios in typical dividend sectors such as utilities or consumer goods, they miss opportunities in dynamic markets. Some sectors, such as defence, fossil fuels and tobacco, are traditionally known for their attractive dividends. These sectors often distribute a large portion of their profits to shareholders. However, this can present a dilemma to investors with a strong focus on sustainability.

4. Tax implications

Dividends are taxed. Belgian dividends are subject to a 30% withholding tax. Anyone receiving dividends from foreign companies is taxed twice: foreign withholding tax and Belgian withholding tax! This can reduce the final dividend by as much as half.

If there is a double taxation treaty between Belgium and the country of origin, a lower withholding tax can be achieved. This depends on several factors such as your tax residence. Good to know: you can recover the withholding tax on dividends to a certain extent through your personal income tax. However, you have to do this yourself. The tax authorities will not calculate this for you*.

*If you want more info on your situation, be sure to contact our Federal Public Service Finance or your tax advisor.

If you want to invest in dividend shares but don't need a regular income, consider investing in an ETF or actively managed fund that reinvests its profits (accumulation) rather than issue them as dividends (distribution). In case of reinvestment, the dividends are settled with the ETF price or the net asset value of the fund. You can find these trackers or funds by searching for the terms “income” or “dividend”. Please note that you should choose accumulation (Acc) rather than distribution (Dis). More information on this is always available in the Key Information Document. Accumulation can be more attractive for tax purposes: because you are not receiving any dividends, you will not pay any withholding tax.

5. Higher dependence on dividends

Too much focus on dividends may ultimately lead you to depend on this source of income. In economically difficult times, companies are likely to reduce or eliminate their dividends, which may cause financial stress for investors relying heavily on dividend income. Of course, you can still sell some of your shares yourself from time to time. This can also be a strategy to provide a regular income if you need it.

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