The Dangerous Illusion of ‘Free Money’ as An Investor (2024)

FAQs

The Dangerous Illusion of ‘Free Money’ as An Investor? ›

The dividend fallacy — believing that dividends are free money — is one of the most common mistakes investors make. In reality, dividends are not “free money.” Dividends are an inflexible, tax-inefficient way to receive investment income while reducing the diversification in a portfolio.

But it's a fallacy, sometimes called the free dividend fallacy. Simply put, if a company you own pays a dividend, the price of the stock drops by the amount of the dividend. So you haven't suddenly become richer.

What Is the House Money Effect? The house money effect is a theory used to explain the tendency of investors to take on greater risk when reinvesting profit earned through investing than they would when investing their savings or wages.

Dividends might feel like free money, but they're not.

The least essential criterion while making an investment decision is the mode of investing money. Whether the deposits can be made online or directly by cash or check does not significantly influence the investor's decision-making process.

The Fallacy of Wealth refers to the mistaken belief that accumulating wealth is the ultimate indicator of success and happiness. It suggests that people often equate wealth with well-being, assuming that having more money will automatically lead to a better quality of life.

What is the sunk cost fallacy? The sunk cost fallacy is our tendency to continue with an endeavor we've invested money, effort, or time into—even if the current costs outweigh the benefits.

“Snake bite” effect, causing the fear to take risks, have the influence on investor's further decisions and behaviour, and prevents him from profit lock which, in turn, has the impact on profit margin and investment return.

On the other hand, Thaler and Johnson also note that prior losses lead to risk-seeking behavior in situations where future outcomes offering an opportunity to break even look particularly attractive. This result is termed the break-even effect.

Home bias can concentrate clients' assets too heavily in one area, undermining the well-established benefits of diversification and ratcheting up risk.

Can I live off of dividends? ›

Depending on how much money you have in those stocks or funds, their growth over time, and how much you reinvest your dividends, you could be generating enough money to live off of each year, without having any other retirement plan.

Companies that offer dividends provide investors with a regular income as the stock price moves up and down in the market. Companies that don't offer dividends are typically reinvesting revenues into the growth of the company itself, which can eventually lead to greater increases in share price and value for investors.

The tech space is always worth watching when it comes to seeking out the next big thing in investing. Right now it seems that artificial intelligence (AI) is driving that bus and will be for the foreseeable future.

Safe assets are those that allow investors to preserve capital without a high risk of potential losses. Such assets include treasuries, CDs, money market funds, and annuities. There is, of course, a risk-return tradeoff, such that safer assets typically offer comparatively lower expected returns.

The dividend fallacy — believing that dividends are free money — is one of the most common mistakes investors make. In reality, dividends are not “free money.” Dividends are an inflexible, tax-inefficient way to receive investment income while reducing the diversification in a portfolio.

A major explanation why firms pay dividends is the free cash flow hypothesis (Jensen, 1986), which explains dividends as a means to mitigate agency cost of free cash flows. The free cash flow hypothesis is primarily based on the argument that there is a conflict of interest between managers and shareholders.

Arguments Against Dividends

Some financial analysts believe that the consideration of a dividend policy is irrelevant because investors have the ability to create "homemade" dividends. These analysts claim that income is achieved by investors adjusting their asset allocation in their portfolios.

The firm should pay dividend if the payment will lead to the maximisation of the wealth of the owners and if not then the firm should retain profits to finance investment programmes. The relationship between dividends and value of the firm should, therefore, be the decision criterion.