Dangers of a high div strategy

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Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 3:11 pm

http://www.cbsnews.com/8301-505123_162-57555994/why-a-high-dividend-strategy-is-dangerous/

this keeps coming up all the time. Despite the evidence that it's not a good strategy, just a poor value strategy

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Re: Dangers of a high div strategy

Postby Clearly_Irrational » Tue Dec 04, 2012 4:32 pm

I see information about why it's bad right now from a timing perspective. You also describe why it's not a substitute for bonds and it's not the best value play. I agree with all of that. I think a dividend strategy can still be appropriate for some situations, but I suppose that's a different discussion.
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Re: Dangers of a high div strategy

Postby madbrain » Tue Dec 04, 2012 4:35 pm

Would have been nice to spell out the word dividend, I read it as diversification the first time, then figured out that didn't make sense coming from you ...
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Re: Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 5:27 pm

Clearly irrational
I don't know of any time that it's a good strategy or for any one, IMO it's an illusion of safety, that's all
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Re: Dangers of a high div strategy

Postby Clearly_Irrational » Tue Dec 04, 2012 5:39 pm

Given a set of circumstances such that:

1) You're in the distribution phase
2) Preservation of principal is desired
3) Current tax laws don't favor capital gains over dividends
4) A simplistic withdrawal strategy is desired

I think a dividend strategy could be decent component of an overall portfolio in those conditions.
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Re: Dangers of a high div strategy

Postby dkturner » Tue Dec 04, 2012 5:49 pm

Clearly_Irrational wrote:Given a set of circumstances such that:

1) You're in the distribution phase
2) Preservation of principal is desired
3) Current tax laws don't favor capital gains over dividends
4) A simplistic withdrawal strategy is desired

I think a dividend strategy could be decent component of an overall portfolio in those conditions.


Ask Larry how the DFA Large Value Fund (DFLVX) has performed compared to the Vanguard Equity Income Fund (VEIPX) and the Vanguard Value Index Fund (VIVAX) since its (DFLVXs) inception. Now ask him to explain why an investor, who doesn't have access to DFLVX, should prefer VIVAX over VEIPX.
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Re: Dangers of a high div strategy

Postby 3504PIR » Tue Dec 04, 2012 5:53 pm

[x] SDY is a poor etf
[x] equities are a poor substitute for bonds
[ ] compairing treasuries with SDY is logical
[ ] author explains his definition of "high" dividend
[ ] author makes his point using valid statistics or examples of dividend investing

2 out of 5. There are valid reasons to implement a dividend growth strategy in filling LC space in a balanced portfolio.
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Re: Dangers of a high div strategy

Postby hoops777 » Tue Dec 04, 2012 6:05 pm

What about investing in only blue chips with a decent dividend like JNJ,MCD ETC.You are retired and need the income and your dividends supply what you need.If the market tanks you still get your dividends without having to sell shares at a loss.I am not talking junk stocks that might suspend payments.You can set up a pretty solid income source with all high quality companies with a mix of the blue chip stocks,the best MLP's,Reits and a few canadian stocks and utilities with looooong histories.If I own the market and I have to sell shares in a downturn,those shares are gone.If PG drops 20% and I keep getting the dividends when the market recovers I have not lost any money.Depending on the mix of stocks ,these can also be less volatile than the market.Thoughts from Larry??
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Re: Dangers of a high div strategy

Postby 3504PIR » Tue Dec 04, 2012 6:08 pm

hoops777 wrote:What about investing in only blue chips with a decent dividend like JNJ,MCD ETC.You are retired and need the income and your dividends supply what you need.If the market tanks you still get your dividends without having to sell shares at a loss.I am not talking junk stocks that might suspend payments.You can set up a pretty solid income source with all high quality companies with a mix of the blue chip stocks,the best MLP's,Reits and a few canadian stocks and utilities with looooong histories.If I own the market and I have to sell shares in a downturn,those shares are gone.If PG drops 20% and I keep getting the dividends when the market recovers I have not lost any money.Thoughts from Larry??


Exactly.
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Re: Dangers of a high div strategy

Postby Call_Me_Op » Tue Dec 04, 2012 6:22 pm

Clearly_Irrational wrote:Given a set of circumstances such that:

1) You're in the distribution phase
2) Preservation of principal is desired
3) Current tax laws don't favor capital gains over dividends
4) A simplistic withdrawal strategy is desired

I think a dividend strategy could be decent component of an overall portfolio in those conditions.


1.) Can use total return approach.
2.) Div stocks do not preserve principal.
3.) Don't let the tax tail wag the dog, especially when tax law can change on a dime.
4.) No more simplistic than withdrawing from any portfolio.
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Re: Dangers of a high div strategy

Postby JupiterJones » Tue Dec 04, 2012 6:22 pm

madbrain wrote:Would have been nice to spell out the word dividend, I read it as diversification the first time, then figured out that didn't make sense coming from you ...


Me too, FWIW. :shock:

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Re: Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 6:28 pm

3504PIR and hoops
First, the divs are illusion of safety, as they can certainly be cut if not eliminated
Second,
1) Can use total return approach.
2.) Div stocks do not preserve principal.
3.) Don't let the tax tail wag the dog, especially when tax law can change on a dime.
4.) No more simplistic than withdrawing from any portfolio.


Remember when company pays div stock price drops by same amount and you can create your own dividends with a total return approach. It's the same thing

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Re: Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 6:30 pm

3504PIR
I cannot think of any logical reasons for the dividend strategy. There is certainly no evidence I am aware of to justify it, nor any logic I can think of.

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Re: Dangers of a high div strategy

Postby Sbashore » Tue Dec 04, 2012 6:35 pm

hoops777 wrote:What about investing in only blue chips with a decent dividend like JNJ,MCD ETC.You are retired and need the income and your dividends supply what you need.If the market tanks you still get your dividends without having to sell shares at a loss.I am not talking junk stocks that might suspend payments.You can set up a pretty solid income source with all high quality companies with a mix of the blue chip stocks,the best MLP's,Reits and a few canadian stocks and utilities with looooong histories.If I own the market and I have to sell shares in a downturn,those shares are gone.If PG drops 20% and I keep getting the dividends when the market recovers I have not lost any money.Depending on the mix of stocks ,these can also be less volatile than the market.Thoughts from Larry??


I'm not Larry, but one thing occurred to me. What if your stock drops 50 % because they drastically cut dividends and it stays down for years? Does your strategy account for that? It happened to me a long time ago, with a "widows and orphans", "bond" like stock. IBM.
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Re: Dangers of a high div strategy

Postby Clearly_Irrational » Tue Dec 04, 2012 6:41 pm

larryswedroe wrote:Remember when company pays div stock price drops by same amount and you can create your own dividends with a total return approach. It's the same thing


It's very similar, and for most cases I don't recommend it, but I'm not sure I agree it's the same thing. I would argue there are a couple of advantages:

1) It's conceptually simple and thus can have a beneficial psychological effect to encourage the investor to hold on
2) You don't suffer from the same sequence of returns risk
3) Dividends tend to represent the natural sustainable withdrawal rate which makes figuring out how much to pull out fairly easy

For most people, in most cases, a total return approach will still be a better choice.
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Re: Dangers of a high div strategy

Postby Browser » Tue Dec 04, 2012 6:44 pm

Geoff Considine wrote an interesting analysis of the high-dividend strategy, compared to other value strategies. He concludes that the high-dividend strategy is not an inferior strategy on a risk-adjusted basis.

1) Portfolios constructed based on high D/P typically have lower beta, or market risk, than portfolios based on high E/P. Referring to studies conducted by Michael Nairne and Buckingham Asset Management, both using data from 1952 through 2011, from Ken French’s website, he notes:
First, neither Nairne nor BAM noted that the high-E/P portfolio has a beta (with respect to the S&P 500) of 1.10, while the high-dividend-yield portfolio’s beta is only 0.90.

2) Comparisons between value strategies have failed to take of account of a special feature of dividend stocks – reduced estimation risk, the risk associated with the difficulty of estimating future returns.
Because both dividends and call option premiums are a form of tradeoff between future price appreciation and cash in hand, we can think of a portfolio that pays a dividend as implicitly having sold a call option. Through this new lens, we can re-compare dividend paying stocks to other value strategies.

When you buy dividend-paying stocks, as when you sell call options, you are trading uncertain future cash flow for realized cash flow today. In exchange for safe and
predictable income, you sacrifice potential gains, and you retain most the downside risk. Neither selling covered calls nor choosing dividend-paying stocks is a free lunch. A dividend strategy is a value strategy with reduced estimation risk in realizable income.

The question for investors considering dividend-paying stocks (or selling covered calls) is how much upside they are willing to sacrifice in order to reduce the estimation risk associated with price returns. If you are willing to take equity-like levels of volatility but reduce estimation risk in income, you should find dividends and covered calls very attractive

In other words, taking beta and estimation risk into consideration, a dividend-based strategy implicitly involves giving up some potential return in exchange for reduced market and estimated return risk. It is not inferior to other value strategies on a fully-accounted risk-adjusted basis.

http://www.advisorperspectives.com/newsletters12/The_Superiority_of_Dividends.php
If we have data, let’s look at data. If all we have are opinions, let’s go with mine. – Jim Barksdale
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Re: Dangers of a high div strategy

Postby DualIncomeNoDebt » Tue Dec 04, 2012 6:56 pm

Suppose you like dividends, but don't want single-stock risk, but still are looking for income. What is the alternative? Yes, I realize Vanguard has a dividend ETF, but if a dividend strategy is out, but you still want recurring income without touching principle, then what? Perhaps a Vanguard balanced fund with monthly distributions, or maybe even a high-yield Vanguard bond fund with monthly distributions? Would this be a preferred method to single ticker dividend payers?
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Re: Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 7:32 pm

Clearly irrational
I agree only with the first of your three points, and not even sure that's right, it might be right for some people. They still see the value of the assets falling so not sure it makes a difference, though grant it might. The others I disagree with.

Browser,
In the pieces I wrote we used the model to explain the returns and the 3 factor model explains the returns very well. So there is nothing unique there and it's just a value oriented strategy with poor results relative to other value strategies. And don't see why divs make estimating returns any less risky. In fact, theory says dividend policy doesn't matter. There are many cases of dividends being cut an even eliminated. And the tax laws made dividends so unattractive that most companies stopped paying them. So a high dividend strategy also sacrifices diversification

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Re: Dangers of a high div strategy

Postby Clearly_Irrational » Tue Dec 04, 2012 7:38 pm

larryswedroe wrote:And the tax laws made dividends so unattractive that most companies stopped paying them. So a high dividend strategy also sacrifices diversification


I think those are very important points. Dividends tend to be very sector concentrated nowadays and the tax treatment isn't near as good.
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Re: Dangers of a high div strategy

Postby baw703916 » Tue Dec 04, 2012 7:46 pm

Larry,

What about utility stocks? I know that DFA specifically excludes them from their value funds, even though on paper they have high BtM (this part makes sense to me in terms of Fama and French's explanation of the value premium as a risk story). They are a relatively low beta sector (0.6, if I remember correctly). I'm not proposing them as a bond substitute, but how do they fit into the scheme of things? Do they have some bond-like characterisics, as HY bonds have some equity-like characteristics? Do they have worse risk-adjusted return than other investments, and if so, why doesn't the market demand a higher return?

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Re: Dangers of a high div strategy

Postby Jerilynn » Tue Dec 04, 2012 7:47 pm

larryswedroe wrote:3504PIR
I cannot think of any logical reasons for the dividend strategy. There is certainly no evidence I am aware of to justify it, nor any logic I can think of.

Larry


Fair enough. Let's say someone currently has 10% of his portfolio in Vang High Dividend Yield ETF (VYM) and has been keeping that AA for the last 10 years. Would you suggest he sell all or part of it right now? And what would you suggest he buy instead?
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Re: Dangers of a high div strategy

Postby steve roy » Tue Dec 04, 2012 8:29 pm

Larry:

Thanks for posting this. It leads me to some questions:

I'm putting in place a 70% bond/30% stock strategy, and tilting to value and small cap value as you have recommended. My plan is to split my domestic stock allocation between large and small cap, with small cap being split 50/50 between Vanguard's small cap index and small cap value index.

For large cap, I plan to split between Total Stock Market and a large cap value index. A few months ago I bought me a slug of Vanguard High Dividend Yield etf (VYM). My question(s): Should I have a different asset allocation to execute the Swedroe 70/30 value tilt? Did I make a mistake purchasing VYM? Is there something better? I am principally in Vanguard's equity index funds, so I'm building the 70/30 from Vanguard bond and stock funds.

Thanks for any light you can shed on the above. Much appreciated.
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Re: Dangers of a high div strategy

Postby Call_Me_Op » Tue Dec 04, 2012 8:30 pm

JL,

I think Larry's main point is not to view dividend stocks as a good substitute for bonds. Holding 10% high div stocks in a fund is fine, as long as you understand it is part of your equity allocation.
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Re: Dangers of a high div strategy

Postby hoops777 » Tue Dec 04, 2012 8:46 pm

Thre is a fund with many ,many years of success that you all know ...Wellesley.They are roughly 65 % bonds and 35% dividend stocks.Care to explain the success for what 80 years or more of that fund?I do not think anyone was talking about a 100 % allocation of divid stocks but using them with your bond allocation instead of the total mkt.
Also,again,if I invest 25k each in say T,PG,JNJ and MCD and just take the dividends which would avg almost 4k per year and do not sell any shares,I will be better off in a down mkt than someone who sells shares of the total mkt and has less when the mkt recovers.Not to mention the fact that those stocks in general are less volatile to begin with.
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Re: Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 9:47 pm

Jerilyn
First, it's a matter of what is optimal and then if not optimal what the tax cost of a change is relative to the expected benefit. And remember the tax cost is certain while the expected benefit is not.
So that is what you would have to evaluate.
Second, if replacing it you should look at how the factor exposure is achieved. Suggest reading the blog posts I listed on the subject--see my article for three of the links, one discusses VIG specifically

I hope that is helpful
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Re: Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 9:50 pm

steveRoy
Suggest you read the blog post of today and the three links within the article. That should provide some guidance.
Note the key is that you must understand that Hi Dividend strategy is not bad, just a poor value strategy and not a substitute for safe bonds. If you get that right you're doing okay.
For value you want not high yield but low P/B, low P/E or low P/C all better historical results than Divs, reason IMO is that people overpay for divs, confusing them with safer bonds!!!
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Re: Dangers of a high div strategy

Postby zotty » Tue Dec 04, 2012 10:46 pm

I am dangerously close to going off topic, but I think there are some cases where the equity risk starts to make sense.

An example from today:

Intel's yield is 4.5% (90 cents a share)

Intel announced (today) that they are selling 6 billion in bonds. 5 year bond at 1.35%, 30 year at 4%.

http://finance.yahoo.com/news/intel-ann ... 00909.html

Granted, most of us would say "neither/nor" instead of "either/or".

Isn't this a situation where equity risk and current income strongly favor an equity stake?
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Re: Dangers of a high div strategy

Postby stlutz » Tue Dec 04, 2012 11:13 pm

These discussions gets problematic when equity dividends are treated the same as a mutual fund dividend.

Is is true that if mutual fund XYZ pays a dividend today, its price will decline accordingly and things are no different than if they hadn't paid a dividend (save for taxes).

With a stock, it's a little different. It is true that the stock price price does decline when a dividend is paid. But that is where the similarity ends. When companies pay dividends, it's investors who are then deciding how to allocate that capital. If the company doesn't pay a dividend, then management decides how to allocate that capital. They may buy back stock. They may acquire other companies. They may invest in new ventures. They may just stockpile cash on the balance sheet. Academic research has shown that most of those options don't actually help shareholders.

All other things being equal, a company that distributes most of its profits to shareholders is better than that one that does not.
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Re: Dangers of a high div strategy

Postby DaveS » Tue Dec 04, 2012 11:19 pm

Reading this makes me feel so old. I remember when Con Ed, the NYC utility ,had to pay a dividend of about 8% because no one wanted to buy the stock except widows and orphans. Back then the trendy stocks were called the "nifty fifty." Avon, Xerox, Gulf & Western were some. Fad's change but the result is always the same. Thanks for the article and the memories. Dave
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Re: Dangers of a high div strategy

Postby larryswedroe » Tue Dec 04, 2012 11:20 pm

stlutz
Yes there is some evidence to support that--keeps them from overinvesting in bad projects, making bad acquistions done to just build up the job of the CEO, etc
But there is no evidence that it results in higher returns than other value strategies, in fact it is the opposite as I have shown. IT's the worst of the value strategies

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Re: Dangers of a high div strategy

Postby JArthur » Tue Dec 04, 2012 11:45 pm

Wouldn't a longer comparison be better? VEIPX has been around since 1988 and is a large value, dividend seeking fund.

VFINX $10,000 purchased 03-21-88 all dividends reinvested = $88,467.82
VEIPX $10,000 purchased 03-21-88 all dividends reinvested = $95,791.33
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Re: Dangers of a high div strategy

Postby Jerilynn » Wed Dec 05, 2012 1:24 am

larryswedroe wrote:Jerilyn
First, it's a matter of what is optimal and then if not optimal what the tax cost of a change is relative to the expected benefit. And remember the tax cost is certain while the expected benefit is not.
So that is what you would have to evaluate.
Second, if replacing it you should look at how the factor exposure is achieved. Suggest reading the blog posts I listed on the subject--see my article for three of the links, one discusses VIG specifically

I hope that is helpful
Larry


I guess I don't follow. (sounds like mumbo jumbo, but what do I know, I was always the first one to shout out that the emperor was naked even when he was fully clothed.)

1. What is the definition of 'the high dividend strategy'
2. So, if someone currently owns VIG are you saying they should or shouldn't dump it?
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Re: Dangers of a high div strategy

Postby nedsaid » Wed Dec 05, 2012 1:36 am

I will just speak from experience.

A high dividend strategy can be a bit risky, particularly now that people are chasing yield. These high dividend stocks are sensitive to changes in interest rates. If interest rates rise, money in these stocks could flow back into bonds.

High dividend stocks though they are used as a proxy for bonds are still stocks and thus can be quite volatile.

Make sure that the earnings cover the dividend. If the company is borrowing money or selling assets to meet the dividend, that is a danger sign.

A very high dividend yield can be a signal that something is seriously wrong with the company. The dividend yield might be high because the price of the stock has dropped a lot. If something is seriously wrong with the company, odds are the dividend will be cut. Then you get a double whammy.

If the dividend yield is much higher than the market average or much higher than the average of the industry group the stock is in, that can be a flashing danger signal. Pay attention to market benchmarks!!
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Re: Dangers of a high div strategy

Postby Jerilynn » Wed Dec 05, 2012 2:12 am

nedsaid wrote:
High dividend stocks though they are used as a proxy for bonds are still stocks and thus can be quite volatile.



But that's not what Larry is saying. He is saying that there is no use for any high dividend stock funds/ETFs. (or at least that what I think he is saying)
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Re: Dangers of a high div strategy

Postby rj49 » Wed Dec 05, 2012 4:23 am

DualIncomeNoDebt wrote:Suppose you like dividends, but don't want single-stock risk, but still are looking for income. What is the alternative? Yes, I realize Vanguard has a dividend ETF, but if a dividend strategy is out, but you still want recurring income without touching principle, then what? Perhaps a Vanguard balanced fund with monthly distributions, or maybe even a high-yield Vanguard bond fund with monthly distributions? Would this be a preferred method to single ticker dividend payers?


Wellesley has been the fund to use for those not wanting to touch principal and live off dividends, at least for the past 40 years or so. The combination of high-dividend payers and corporate bonds made a nice payout, with very few down years, and a decent amount of growth. Of course, much of the gains over the decades came from declining interest rates for its 65% bond allocation, so it's difficult to imagine any long-term gains from the bond portion going forward. Its stock portion also only owns 50 or so stocks. If the yield gets back up to 4-5% dividends it might be tempting again for those in the distribution phase wishing to live off principal only.

Another possible option for regular distributions would be the managed payout funds, particularly the one paying 3% of the fund every year--if the growth plus dividends are above that you end up ahead, but in negative periods you can end up eating into principal to get your payouts. It has the further advantage of being diversified into REITs, bonds, foreign, and a bit of commodities and a market-neutral fund, sort of a pretend-endowment fund.
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Re: Dangers of a high div strategy

Postby 3504PIR » Wed Dec 05, 2012 5:45 am

larryswedroe wrote:3504PIR
I cannot think of any logical reasons for the dividend strategy. There is certainly no evidence I am aware of to justify it, nor any logic I can think of.

Larry


I'll provide you with a direct response but would appreciate if you would do the same at least with your definition of "high" dividend strategy as you have yet to do although others in the thread have also asked.

My approach is focused on dividend growth, thus income growth in the LC space of my overall portfolio. I choose stocks with solid fundementals with a long (25+ year) history of dividend increases. Deliberate selection of dividend growth stocks includes a reasonable payout ratio vs EPS and these companies show consistant and steady growth over the long haul. The logical reason for doing so is to establish and maintain a income stream which historically beats inflation. The stocks I hold typically average over an 8% annual dividend growth. To maintain that over the time I've indicated requires the company to maintain steady expansion and growth otherwise, they would not be able to maintain an acceptable payout ratio and thus become risk for cutting dividends. Examples of such companies are KO, MCD, PEP, MMM, PG, etc.

Total return is higher than the S&P 500 (see the S&P 500 Dividend Aristocrats index) over the past decade + - however total return is not the objective. Dividend growth is.

A $1M portfolio with a 60/40 S/B allocation and 50% equity in LC would have $300,000 invested in dividend growth stocks. Yield at purchase averages 3% for me. Over time reinvested dividends and dividend growth compound to have meaningful income from that portion of the portfolio as part of an overall balanced retirement spending/income plan.

I'll also note the you've injected Value investing into the discussion here and in your article, it isn't part of my response or original post that I commented on. Value status would depend on when you buy them correct?
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Re: Dangers of a high div strategy

Postby STC » Wed Dec 05, 2012 9:46 am

3504PIR wrote:
larryswedroe wrote:3504PIR
I cannot think of any logical reasons for the dividend strategy. There is certainly no evidence I am aware of to justify it, nor any logic I can think of.

Larry


I'll provide you with a direct response but would appreciate if you would do the same at least with your definition of "high" dividend strategy as you have yet to do although others in the thread have also asked.

My approach is focused on dividend growth, thus income growth in the LC space of my overall portfolio. I choose stocks with solid fundementals with a long (25+ year) history of dividend increases. Deliberate selection of dividend growth stocks includes a reasonable payout ratio vs EPS and these companies show consistant and steady growth over the long haul. The logical reason for doing so is to establish and maintain a income stream which historically beats inflation. The stocks I hold typically average over an 8% annual dividend growth. To maintain that over the time I've indicated requires the company to maintain steady expansion and growth otherwise, they would not be able to maintain an acceptable payout ratio and thus become risk for cutting dividends. Examples of such companies are KO, MCD, PEP, MMM, PG, etc.

Total return is higher than the S&P 500 (see the S&P 500 Dividend Aristocrats index) over the past decade + - however total return is not the objective. Dividend growth is.

A $1M portfolio with a 60/40 S/B allocation and 50% equity in LC would have $300,000 invested in dividend growth stocks. Yield at purchase averages 3% for me. Over time reinvested dividends and dividend growth compound to have meaningful income from that portion of the portfolio as part of an overall balanced retirement spending/income plan.

I'll also note the you've injected Value investing into the discussion here and in your article, it isn't part of my response or original post that I commented on. Value status would depend on when you buy them correct?


There are a number of issues with your logic.

1: There have been numerous studies over the years that prove that investors are NOT compensated for the additional risk of owning individual stocks. Just look at how many original Dow companies are still around?!
2: If you own enough individual stocks, you can diversify away that risk, but you are also paying more in fee's/commissions which makes this approach FAR less efficient then an index
3: Total return matters. What % each component of Total Return (capital appreciation vs distributions) delivers does NOT.
4: Dividends, including "high quality" dividends can, have, and will again, be CUT in times of stress
5: The illusion of safety, which you are clearly under, has resulted in these stocks being bid up - lowering future expected returns

Will you go broke using this strategy? Probably not. But you are highly likely to under-perform the TSM through added costs, added risk, and paying a premium for a misguided sense of security.

Good luck.
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Re: Dangers of a high div strategy

Postby larryswedroe » Wed Dec 05, 2012 9:59 am

3504PIR

First, I have addressed very specifically what a high dividend strategy is--you rank stocks by dividend yield. Now you can also have a high growth of dividend strategy, which I have also written on. I have blog posts on both strategies and show there is nothing unique there. While you have your opinions there is no evidence to support it. All your points about long term track records of divs and good fundamentals are well known by the market and thus priced. In fact one might logically argue that since these are indicators of sound companies they are less risky and thus priced for lower returns.

As to the last decade--that kind of period is way too short to have any meaning going forward and in fact that performance has only led to very high prices now and low future expected returns. The high valuations which I noted are result of performance chasing by investors to the latest fad, which always ends badly because valuations get high.

As to value status. Irrelevent when you buy them, it's are they value today. And that's simple ranking.

Finally nothing wrong with a high dividend stock, it's just that if that's the only value metric the performance has been less favorable than if you ranked stocks by any other value metric.

Best wishes
Larry
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Re: Dangers of a high div strategy

Postby BBL » Wed Dec 05, 2012 10:14 am

2: If you own enough individual stocks, you can diversify away that risk, but you are also paying more in fee's/commissions which makes this approach FAR less efficient then an index


STC,

On this point and this point alone:

Dividend strategy or not, if you have a large enough portfolio and the inclination to do it, the strategy of owning many large stocks [enough for diversification purposes] to achieve your US LG goal can have certain advantages:

1. No ER
2. More TLH flexibility [individual issues; individual lots]
3. Cap gain realization control [defer, basis step-up to heirs, charitable strategies, gifting strategies, etc.]

The occasional [depending on your brokerage situation] transaction fee for a TLH or rebalance trade, on a large scale portfolio, is much less significant than say an ever-present .10 ER.

A few posters here do this very same thing.
To win without risk is to triumph without glory. Pierre Corneille
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Re: Dangers of a high div strategy

Postby larryswedroe » Wed Dec 05, 2012 11:09 am

blackbelter
Yes those are all advantages of owning individual securities and why we do that for bonds (where you don't need the diversification in Treasuries or CDs and minimal need for munis if you stick with the highest grade), and we also use that strategy to build portfolios for VERY HIGH NET worth individuals.

The problems are you need to own a lot more stocks than people think. And you can really only do it with large caps, unless very high net worth, which means you give up diversification to other asset classes and the risk premiums and diversification benefits. And you cannot do it internationally either. Far too many negatives IMO, as well as giving up convenience funds offer and not having to track the stocks.

Best wishes
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Re: Dangers of a high div strategy

Postby BBL » Wed Dec 05, 2012 11:26 am

Larry,

I’ve considered the merits only under this circumstance:

The allocation to US LG in taxable is 2M or greater [I think the tax benefits are foremost].

At that point I think you are can enter the territory of reasonably adequate diversification [elimination of unsystematic risk].

Like you say I’ve never heard anyone claim this was a good idea for anything but domestic LG.

I’m not so sure I would want to DIY this strategy [at least the implementation phase].

An interesting concept more than a practical consideration for most…
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Re: Dangers of a high div strategy

Postby etarini » Wed Dec 05, 2012 11:39 am

I enjoy reading the dividend threads, and I am amused by the elaborate rationalizations that high-dividend fans use to justify their "logical" choice, when in fact they are only justifying their need to get a certain return, and attempting to minimize their risk by not recognizing it. I have to admit that those dividend numbers are very appealing.

But I keep coming back to this one thought:

When comparing high dividends to, say, highly rated municipal bonds or treasuries or CDs, why wouldn't the ratio of the dividend yield to those other (much lower) returns be the best approximation of the ratio of increased risk?

Put another way, are high-dividend stocks some glaring risk/rewared market inefficiency that can be exploited?

I don't think so.

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Re: Dangers of a high div strategy

Postby 3504PIR » Wed Dec 05, 2012 11:43 am

larryswedroe wrote:3504PIR

First, I have addressed very specifically what a high dividend strategy is--you rank stocks by dividend yield. Now you can also have a high growth of dividend strategy, which I have also written on. I have blog posts on both strategies and show there is nothing unique there. While you have your opinions there is no evidence to support it. All your points about long term track records of divs and good fundamentals are well known by the market and thus priced. In fact one might logically argue that since these are indicators of sound companies they are less risky and thus priced for lower returns.

As to the last decade--that kind of period is way too short to have any meaning going forward and in fact that performance has only led to very high prices now and low future expected returns. The high valuations which I noted are result of performance chasing by investors to the latest fad, which always ends badly because valuations get high.

As to value status. Irrelevent when you buy them, it's are they value today. And that's simple ranking.

Finally nothing wrong with a high dividend stock, it's just that if that's the only value metric the performance has been less favorable than if you ranked stocks by any other value metric.

Best wishes
Larry


Larry,

Thanks very much for the response and for the providing the definition preventing me from reading other blog entries to find/research what it is. I'll look at your dividend growth strategy paper/blog entry for sure.

I think we are saying the similar things about value perhaps from a different perspective. I'm referring to individual equities and purchase at a exceptable valuation. You are possibly talking about a category ranking of what is in the value category today, which I'm fine with. i.e. a value fund would hold value ranked stocks in its portfolio which are considered value today. I buy and hold LC stocks at an acceptable valuation (to me). I don't move equities out of my portfolio based on price or ranking Value ranking.

I don't have a problem with an assumption that dividend stocks are at a higher valuation currently based upon their popularity. I do know that I'm not adding any holdings and haven't been for the past 6 months. Valuations of what I hold and what I would like to hold are beyond a reasonable price to me. I don't and haven't claimed to be doing anything unique or outside the knowledge of the market.

To illustrate my point, you said, "The high valuations which I noted are result of performance chasing by investors to the latest fad, which always ends badly because valuations get high." Which I agreed with above. Using that logic, I should have a reasonable expectation of determining when valuations are low and when to enter into a position to hold for the long term.

Finally, and I'll be more blunt this time. You are correct, a 10 year sample is a 10 year sample. But honestly I could care less about underperforming the TSM, DOW, S&P 500 or any other measure. These discussions always end up at total return which I perfectly understand BH's being concerned if not obsessed with. I'm not.

Again, thanks very much for the thoughtful response and providing your perspective, which I will dig further into.
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Re: Dangers of a high div strategy

Postby empb » Wed Dec 05, 2012 11:47 am

3504PIR wrote:These discussions always end up at total return which I perfectly understand BH's being concerned if not obsessed with. I'm not.

There's a reason for that: it's the only thing that matters!
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Re: Dangers of a high div strategy

Postby Browser » Wed Dec 05, 2012 11:56 am

larryswedroe wrote:Clearly irrational
I agree only with the first of your three points, and not even sure that's right, it might be right for some people. They still see the value of the assets falling so not sure it makes a difference, though grant it might. The others I disagree with.

Browser,
In the pieces I wrote we used the model to explain the returns and the 3 factor model explains the returns very well. So there is nothing unique there and it's just a value oriented strategy with poor results relative to other value strategies. And don't see why divs make estimating returns any less risky. In fact, theory says dividend policy doesn't matter. There are many cases of dividends being cut an even eliminated. And the tax laws made dividends so unattractive that most companies stopped paying them. So a high dividend strategy also sacrifices diversification

Larry

Larry
I don't believe that Considine is disputing your conclusion that a high-dividend strategy may have lower expected returns than other value strategies, such as those based on high E/P or high B/P. And for all I know high-div may be overpriced in the market right now because investors have been chasing returns. However, Considine's point seems to be that high-div is not just a value strategy. It is also a strategy to help minimize the risk that realized investment returns will differ substantially from expected returns; i.e., to help manage "estimation risk".

Total equity return results from two components: price change and dividend payments. It is simply a fact that the predictability of dividend payments is higher than the predictability of price changes in the underlying securities. If a larger proportion of total return is the result of aggregate dividend payments, then the result is lower volatility (higher predictability) in total returns; i.e., dividends can "cushion" total returns. It may be that other value strategies have higher expected total return, but the variability of realized returns will be more highly correlated to stock price changes than to changes in dividends. So it will consequently be more volatile; i.e., there is higher estimation risk. That is the "cost" of following such strategies, compared to a high-div strategy. The "cost" of following a high-div strategy is that it has a lower expected return than other "value" strategies. You are trading off expected return for a more predictable return. That might be important for some investors; particularly those who depend on the cash flow from their investments for a dependable income stream.

To illustrate, I compared the volatilities of the funds in Larry's article over the last 3 years. Over this period, the volatility of VFINX (S&P 500) was 15%, while Beta is 1.0. SDY had an average annual SD of 12%, with Beta = 0.76. DFLVX had an average annual SD of 19%, with Beta = 1.24. So DFLVX (which is the most "valuey") was also the most risky in terms of total returns over the last 3 years. SDY (which is the high-div) was the least risky with an average SD of 12% with a Beta that was just 3/4 of the S&P 500.

Seems to me that the high-div strategy is not as "dangerous" as other value strategies, at least viewed in terms of the predictability of total returns. It's a risk-return story.
Last edited by Browser on Wed Dec 05, 2012 12:52 pm, edited 4 times in total.
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Re: Dangers of a high div strategy

Postby garlandwhizzer » Wed Dec 05, 2012 12:36 pm

I do not believe that dividend based strategies are attractive at present in the US market because they have been overbought and over-paid-for during the turmoil of recent years, which has reduced their level of intrinsic value relative to other value strategies.

However, just to bring up a few points in favor of high dividend strategies...

First of all, high dividend payers as a group, by paying out cash to stockholders, have less cash for corporate executives to play with. Given significant corporate cash to dispense, corporate executives often like to make acquisitions of other firms, essentially giving themselves a bigger job, or reward themselves and their pals on the board of directors with stock options. This has been particularly true in the tech sector, which in past years paid little or no dividends in spite of huge profits, claiming that cash was better invested to grow their companies bottom line. This led to multiple disastrous acquisitions (HP, CSCO, MS, etc.,) which successfully squandered billions of dollars and multiple stock repurchases which had the same effect, buying high as the stock price declined. A common game played was to repurchase a huge amount of shares which looked good in the headlines and later quietly have the board of directors issue more shares which vanish at least in part into stock options for key executives and often the same board members who approved this subterfuge, resulting in no or little decrease in net share count and a large bonus to the key employees who arranged this. Although this is not a black and white issue, high dividend payers can also abuse shareholders, paying out cash every quarter aligns the interest of management more closely with shareholders in my opinion.

Second, although results demonstrate that other value strategies outperform dividend focused strategies long term, dividend focused strategies tend to outperform all other value strategies in a declining market. In a rising market dividend strategies in general underperform.

Third, while other value strategies outperform dividend strategies over long time periods, Jeremy Siegel argues that dividend paying stocks have outperformed non-dividend payers in the S&P 500 over the last 60 years, and that each quartile of increased dividend payment performs better than the lesser quartile before it. In other words, dividend strategies don't outperform value strategies long term but do outperform total market strategies, perhaps due to the absence of growth metrics among dividend payers.

Personally I think dividend strategies in the US market are at present overexploited, but perhaps not so in segments of the international market.

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Re: Dangers of a high div strategy

Postby Clearly_Irrational » Wed Dec 05, 2012 1:22 pm

larryswedroe wrote:First, I have addressed very specifically what a high dividend strategy is--you rank stocks by dividend yield. Now you can also have a high growth of dividend strategy, which I have also written on.


If someone is buying purely based on the yield then I'd say yes, that's a terrible strategy and not one I'd ever recommend. Many of those stocks are beaten down for a reason.
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Re: Dangers of a high div strategy

Postby Clearly_Irrational » Wed Dec 05, 2012 1:23 pm

larryswedroe wrote:The problems are you need to own a lot more stocks than people think.


I'm thinking at least 50?
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Re: Dangers of a high div strategy

Postby Clearly_Irrational » Wed Dec 05, 2012 1:25 pm

empb wrote:
3504PIR wrote:These discussions always end up at total return which I perfectly understand BH's being concerned if not obsessed with. I'm not.

There's a reason for that: it's the only thing that matters!


Cash flow and net worth are not the same thing. The importance varies along a wealth spectrum. The less you have the more cash flow is important, while the more you have the more net worth is important.
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Re: Dangers of a high div strategy

Postby grayfox » Wed Dec 05, 2012 1:43 pm

empb wrote:
3504PIR wrote:These discussions always end up at total return which I perfectly understand BH's being concerned if not obsessed with. I'm not.

There's a reason for that: it's the only thing that matters!


Total return is not all that matters. There is also how much risk you take to get that return.
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