Why the popularity of dividends? What's the counterargument?

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IPer
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Re: Why the popularity of dividends? What's the counterargum

Post by IPer »

ogd wrote:Re: popularity. Those who like dividends most seem to believe that the dividend stock is like a combination stock + bond of sorts. But this is not true -- the dividend comes from the earnings of the company, payments are the first thing to get suspended when it gets into trouble, and even if the next payment is made but the future looks horrendous, the penalty to the stock price will more than "compensate" for having received that last good-times payment.

It's also worth remembering that perpetual bonds would be horribly volatile -- a move from 1% to 2% (akin to a company "falling behind" the rest of the market's earnings) would cost a perpetual bond 50% of its value! Having an expiration date, often short, is a big part of the stability of bonds. With stocks, the stock price keeps you bound to the long term future of the company, indefinitely.

Then there is the argument that dividends indicate/enforce good executive stewardship, but this doesn't seem to help in practice, or dividend companies would consistently fare better. Besides, insisting on 3% of your money being handled just-so ("real", "not fake-able", "not spent on fluff") while happily leaving 97% in the hands of the very same team seems like a strange concept to me. You gotta ultimately trust these guys (in aggregate) because it's the only known way to grow your wealth at a respectable rate.
I like dividend stocks and I know they have nothing to do with bonds, other then that many if not all of these dividend growth
companies deal with and support the bond market!
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kolea
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Re: Why the popularity of dividends? What's the counterargum

Post by kolea »

ogd wrote: It's a seductive argument, but think about it TwoByFour -- it doesn't actually seem to help in recessions. The total return numbers you see everywhere are with dividends reinvested, meaning that whether you spend dividends or sell shares of a dividend-less stock, you are "costing yourself" the same amount of invested shares. So we should be able to see the "spender" advantage of dividends as a difference in total return, and we don't.

To put it another way, generating income from dividends forces you to not buy shares that will likely recover in value, compared to the baseline total return (without spending). If you try to write down a scenario where stock A pays you a dividend that puts you in a better place that selling the dividend-less stock B, you will mathematically find that stock A's total return outpaced stock B at least temporarily during the recession. This gives you a hypothesis that you can verify using simple total returns, and it turns out to be false historically.

(I said it was seductive because I used to think dividends did have at least this advantage, but fellow poster Ketawa patiently convinced me otherwise, a while back)
Well, I could certainly be wrong on this; I have no evidence, only intuition. Intuitively, it seems that the total return symmetry between the two asset types was broken by the fact that dividends remain largely unaffected in a decline.

Your argument that this should show up as an out-performance of dividend stocks over non-dividend stocks in a recession if it were true seems valid. However when I look at some dividend focused funds (like VDIGX), they did indeed outperform VTSAX in 2008/2009. But is that a good comparison? That is the difficulty here - it is hard to find an apples-to-apples comparison to make. There are lots of factors in play and it is not easy to isolate the effect of dividends from others.
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ogd
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Re: Why the popularity of dividends? What's the counterargum

Post by ogd »

TwoByFour wrote:Well, I could certainly be wrong on this; I have no evidence, only intuition. Intuitively, it seems that the total return symmetry between the two asset types was broken by the fact that dividends remain largely unaffected in a decline.

Your argument that this should show up as an out-performance of dividend stocks over non-dividend stocks in a recession if it were true seems valid.
The argument about the equivalence of dividends-with-withdrawals and total return comparisons is something I'm certain of. Whether it was or not visible is a matter of history and not mathematics, so I'm not as certain but still fairly positive.
TwoByFour wrote:However when I look at some dividend focused funds (like VDIGX), they did indeed outperform VTSAX in 2008/2009. But is that a good comparison? That is the difficulty here - it is hard to find an apples-to-apples comparison to make. There are lots of factors in play and it is not easy to isolate the effect of dividends from others.
Yes, it can be hard to find apples to apples. VDIGX did well because it's growth-y and more importantly light on FIRE which really took it on the chin in this crisis. VIGAX the growth fund did considerably better than the market but not as well.

But here's the thing -- VDIGX isn't actually a high-dividend fund, so it's not the best to study the effects of dividend payments specifically during the crisis. Its cousin VHDYX is and guess what -- it actually underperformed the market. Think about it: those 50% higher dividends, being used to buy shares at the best time ever to buy shares -- and still nothing. I'm not sure that is apples to apples either vs sectors, but at the very least what we have here is the cautionary story of concentrating in sectors because of dividends -- getting lucky with VDIGX, not so much with VHDYX.

I've tried to do enough digging on my own to convince myself that at least it's not obvious either way, and for the rest I trust the academics who would have noticed the dividend total return story by now. Instead, what they tell me (to the degree I even trust those pronouncements for the future, which btw undermines my argument a little but doesn't kill it) -- is that in terms of factors dividend is no more than a manifestation of value. And btw you can't say the opposite because it's possible to distinguish which was the decisive factor (by looking at dividend-within-value and value-within-dividend) and value was it, not dividend.

So whatever the story is with dividends, it hasn't panned out historically. It may pan out (as per above -- who knows, right?), but it deserves reserved enthusiasm at best. Meanwhile, diversification, taxes and the sheer fashionability of dividend stocks wins it for me, on the broad market index side.

Edit: grrr, many tiny corrections including tickers. Please refresh :)
cjking
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Re: Why the popularity of dividends? What's the counterargum

Post by cjking »

Aptenodytes wrote:@cjking, I think I agree with everything you say except for your first statement:
(if you have a sensible equity allocation) you can be confident that your income stream will never run out.
I am pretty sure that is false. Everything I've read suggests that dividend-based portfolios are no less likely to never run out than non-dividend based portfolios. Unless you define "sensible equity allocation" to mean "the income stream will never run out," then it is true by definition.
The "you can be confident" was an important part of what I was saying. I wasn't saying that dividend stocks were safer, I was saying that by spending dividends an investor could be confident his withdrawal strategy was safe. I wasn't even necessarily assuming he was tilted toward dividend stocks, a "sensible equity allocation" for me would by default mean a country or world stock index.

If an investor looks at total return, he looks at a number that may be up 20% one year, and that he knows could be down 50% the following year. He doesn't know what income he can take without running down capital.

The dividends stream, a portion of profits the directors of his companies hand out, while keeping some back for reinvestment, answers that question for him, without him having to peform any analysis or look at company accounts, or browse financial web sites to find index earnings yields.

Actually, though the point of this response was meant to be that I wasn't claiming there was difference in the sustainability of taking a given income from high-dividend shares, I'm now going to make the claim that there can be. The reason is that I've just realised that I have the smoothed yield (1/PE10) for the Vanguard world high yield fund at 5.0%, that for the underlying world index at 4.1%, which means the implied fund of low-yielding shares (which doesn't exist but would consist of companies in the world index that are not in the world high-yield index) must have a yield of 3.2%. So I (controversially) predict that the high-yield fund will have a considerably higher return than its complement.

I don't think this will be true for the US high-yield fund. My rationale for assuming differing country PE10s predict different future returns is that different stock-markets mainly serve different populations, there isn't extensive enough international investing to level all markets to the same valuation. (I have no evidence for this, other than the fact PE10s are different, it's just an assumption I make.) Within each stock-market I assume efficiency does exist, so I assume US low and high-yield shares have the same expected returns. The world high-yield fund has much lower exposure to expensive US shares than does the overall world index.

(I don't know if the world high-yield fund is available/suitable for US investors, anyone eccentric enough to follow my ideas might want to look at a world-ex-US fund, for which I calculate 1/PE10 = 5.2%, approaching 2% more than the yield of US shares.)
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Re: Why the popularity of dividends? What's the counterargum

Post by cjking »

TwoByFour wrote:Dividends returns are largely uncorrelated with equity price. When the market is in decline, if you are generating income from capital, you will have to sell more shares of your equity holdings to generate the same income. Of course that is the last thing you want to do in a market decline. But if you are generating income from dividends you are not forced to sell shares that will likely recover in value. To me, that is one argument for favoring dividend equities, at least when you are retired.
I see someone has already replied to this. I am another person who used to believe what you are saying here, but have since changed my mind. I'll put my counter-argument as concisely as I can.

If markets are efficient, the expected return on a high-dividend stock and it's no-dividend competitor are the same at all times, including every second of the period surrounding the dividend payment. It is very bad to sell a stock (for income) when the price has plummeted, but if at that same bad moment you spend (rather than reinvest) the same dollar amount of dividend income, you are giving up exactly the same amount of expected return.
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Aptenodytes
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Re: Why the popularity of dividends? What's the counterargum

Post by Aptenodytes »

3504PIR wrote:
Aptenodytes wrote:My sense of the best explanation: It is similar to the reason people like to play slot machines that offer lots of frequent small winnings, as opposed to a small number of bigger wins. It feeds a behavioral weakness for the appearance of regular gains, without regard to the actual long term gains.

The core counterargument amounts to saying that dividends are a reasonable indicator of value. I don't think it holds any weight -- there are better metrics for value.

A more sophisticated counterargument, which amounts to a synthesis of the two opposite views, would be something like this: there are some people who are not prepared to cope with the volatility of the stock percentage they should be holding on objective grounds, taking into account their needs and objective abilities. Some of these people can be nudged towards living with the right stock percentage by tilting their stock portfolios heavily to dividend stocks. Even though what the dividends do in the portfolio is pure illusion, it is an illusion which for these people serves a useful purpose -- it helps them stick to their plan by feeding them small-regular rewards. The same way casinos keep people feeding those quarters in to slots by manipulating brain chemistry with small regular rewards, dividends can trick these people into doing the right thing.

I don't think there's any need to be doctrinaire about any of this. And certainly there's no point to trying to force people to accept mathematical principles that make sense in the abstract but which make them deeply uncomfortable in practice. If tilting to dividend stocks helps you sleep easier at night, and thereby helps you maintain an appropriate stock percentage, then don't let anyone talk you out of it.
Forcing people to accept mathematical principles? Slot machines? Not prepared to cope with volatility?

You have no idea what you're talking about. What is the mathematical principle of having a total return portfolio in a market that has a negative 10% return for 10 years? Are you prepared to cope with volatility?
You are asking a very basic question, so I don't know exactly what to focus on. Perhaps the most basic thing is that high-dividend stocks don't perform better in such environments than other stocks. Also, you don't know ahead of time what returns are going to be in advance. The mathematical principles are mostly just simple arithmetic.
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rca1824
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Re: Why the popularity of dividends? What's the counterargum

Post by rca1824 »

I think the lure of dividends, besides being a historical relic from an era of high transaction costs, is that it simplifies mental accounting, withdrawal strategies, and has a feel-good anchoring bias. A person can passively buy and hold dividend-paying stocks forever, and only consume the dividend, without having to think about the optimal number of shares to liquidate to generate the optimal income stream. This will be far from optimal, but perhaps for the novice investor it works well enough. The novice investor is also unfamiliar with the concept of opportunity cost, so he thinks he can consume the dividend "for free" without touching his principal, without realizing that consuming the dividend comes at the opportunity cost of increasing the share price. In summary, dividend investing is a trap for novice investors. It might be something I would recommend for my grandmother so she doesn't have to fiddle with selling shares.
Monthly or yearly movements of stocks are often erratic and not indicative of changes in intrinsic value. Over time, however, stock prices and intrinsic value almost invariably converge. ~ WB
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Re: Why the popularity of dividends? What's the counterargum

Post by jebmke »

rca1824 wrote:I think the lure of dividends, besides being a historical relic from an era of high transaction costs, is that it simplifies mental accounting, withdrawal strategies, and has a feel-good anchoring bias.
I think that is true. I know quite a few retirees. Excluding ones who have few assets and mainly live off pension+SS, they generally fall into two categories. One, people like me who withdraw from their assets based on judgement (aka, the Taylor Larimore method) and two, people who live off interest+dividends (plus pension/SS as available). The artificial line between distributions and their total portfolio is a convenient fence. So far, I have yet to meet anyone who uses a mathematical (fixed or variable) withdrawal scheme.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
dbr
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Re: Why the popularity of dividends? What's the counterargum

Post by dbr »

rca1824 wrote:I think the lure of dividends, besides being a historical relic from an era of high transaction costs, is that it simplifies mental accounting, withdrawal strategies, and has a feel-good anchoring bias. A person can passively buy and hold dividend-paying stocks forever, and only consume the dividend, without having to think about the optimal number of shares to liquidate to generate the optimal income stream. This will be far from optimal, but perhaps for the novice investor it works well enough. The novice investor is also unfamiliar with the concept of opportunity cost, so he thinks he can consume the dividend "for free" without touching his principal, without realizing that consuming the dividend comes at the opportunity cost of increasing the share price. In summary, dividend investing is a trap for novice investors. It might be something I would recommend for my grandmother so she doesn't have to fiddle with selling shares.

I think this is pretty much true. At this time stock dividends are not very large. I think someone else mentioned that this actually sets a withdrawal rate that is extremely conservative. In fact a result is that the investor is consuming less than he safely could. Even so, he still needs to engineer this portfolio to get the "right" amount of payout or live with something different from what he wants, and the payments can still be uneven over time. Alternatively there is risk the investor will reach for yield and concentrate his money in riskier investments. It is also very seldom that investors take and spend only the real yield if the portfolio in order to preserve the real, inflation indexed, value of the portfolio. If one is dedicated to preserving the principal this must surely be the real rather than nominal value, or it doesn't seem to make sense. An irony is that the best way to insure and ensure an income stream from assets is to just exactly abandon the portfolio from the beginning by purchasing an SPIA. That does also remove all risk to the portfolio as the value from that point is a guaranteed and never varying zero, which offers no opportunity for hand wringing over the balance.
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Re: Why the popularity of dividends? What's the counterargum

Post by dkturner »

One of the concerns often posted on this website is the fear that an investor will panic during a serious stock market downturn and sell out at the bottom, because (s)he learned, belatedly, that (s)he was too aggressively invested. An investor who is focused on living primarily on the dividends and interest a portfolio produces is less likely to panic during a severe market downturn, because dividend income is more stable than equity prices. The data from 2008 in quite instructive in this regard. Dividend income in 2008 was almost exactly the same as it was in 2007 (up 1.2% actually), despite the fact that equities produced a negative 37% total return. Dividends did decline 20.5% in 2009, but the market began a strong turnaround in early March of that year, so the impetus to sell out would have been blunted by the time the decline in dividend payments began to pinch.

This explanation is purely psychological of course, but psychology is the problem for flighty investors.
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timboktoo
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Re: Why the popularity of dividends? What's the counterargum

Post by timboktoo »

I'm a bit of a dividend fanboy. I dislike owning companies like Facebook and Tesla in Total Stock Market, even if they do well. Owning companies that have paid larger dividends every year makes me feel like I own companies with durable, competitive advantages. This is a feeling, mind you. And I don't act on it. I continue to just hold Total Stock Market. But feelings aren't worthless.

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Clive
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Re: Why the popularity of dividends? What's the counterargum

Post by Clive »

Project a yearly ladder of basic living expenses and income streams for each year ... to expected life expectancy (or perhaps 30 years), accounting for state/private pensions as/when they come online and the sum provides a indicator of the amount that might be deposited/invested into inflation bonds and be drawn-down over that many years.

Surplus amounts above and beyond that basic living expenses cover can be invested more speculatively (stocks) - for growth, that are top sliced to supplement those basic expenses as/when required/desired.

With basic living expenses covered by (inflation) bonds, stocks being held for growth/top-slicing, stock total returns matter more than do dividends ... as dividends may be being reinvested back into buying more shares.

Flies in the face of conventional wisdom that suggests increasing bonds with age, as bonds are being drawn-down, stocks expanding with age. Leaving a more stock heavy portfolio for the next generation/younger heirs.

As a UK investor, any US stocks I hold have 30% withholding tax by default (15% under tax-treaty) deducted from dividends. A 'cost' that can be reduced by holding low/non dividend stocks.

If for instance at age 55 I desire 30K/year basic living expenses, will receive a 15K/year inflation linked private pension as of age 60+, another 15K/year inflation linked state pension age 65+ then 225K dropped into inflation bonds/drawdown. If after that allocation there's another 400K available to be invested in stocks then those stocks can accumulate/be drawn upon to service other expenses over time.
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Re: Why the popularity of dividends? What's the counterargum

Post by rgs92 »

1. Cramer likes to say "you are paid to wait" if you choose a stock with good fundamentals with decent dividends.
2. I have often heard that a large portion of long term equity returns come from dividends (with reinvesting, maybe over 70%, but I forgot the mentioned percentages).
3. The "dogs of the dow" approach is based on dividends.
I'm not endorsing these concepts, just tossing them out for discussion, pro or con.

I also wonder myself if, even if long term returns are worse for a dividend approach, is it better in the income stage of investing, as it may soften the dips in overall portfolio value in major downturns.
But, answering my own last question, in the 2009 collapse, the DVY dividend ETF declined MORE than the S&P500, but of course, that decline was marked by the collapse of financial stocks, which are major dividend generators,
as are energy stock now, so this is happening again.

I wonder if the original question was asked because, in the recent market drop, dividend stock ETFs were hit harder because they held energy/oil stocks.
kolea
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Re: Why the popularity of dividends? What's the counterargum

Post by kolea »

ogd wrote: So whatever the story is with dividends, it hasn't panned out historically. It may pan out (as per above -- who knows, right?), but it deserves reserved enthusiasm at best. Meanwhile, diversification, taxes and the sheer fashionability of dividend stocks wins it for me, on the broad market index side.
This is actually more of a theoretical argument than a substantive one for me since my equities are largely VTI (with a little bit of sector tilting). And realistically, if equities drop in a market decline, bonds will end up over-weighted and that is what I would be selling to make withdrawals. Anyway, I think you and cjking have pretty much convinced me. Good discussions.
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dbr
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Re: Why the popularity of dividends? What's the counterargum

Post by dbr »

rgs92 wrote: 2. I have often heard that a large portion of long term equity returns come from dividends (with reinvesting, maybe over 70%, but I forgot the mentioned percentages).

This is true, but probably not as much as 50%. However it is a fallacy that stocks with higher dividend yield therefore have higher return.
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Riprap
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Re: Why the popularity of dividends? What's the counterargum

Post by Riprap »

Timely article. Total return vs. income and dividends in today's WSJ.

http://www.wsj.com/articles/whats-the-b ... 1426475052

Edited to add:
After reading the article, I would note that this discussion is several orders of magnitude better than the article. :oops:
Last edited by Riprap on Mon Mar 16, 2015 1:45 pm, edited 1 time in total.
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ogd
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Re: Why the popularity of dividends? What's the counterargum

Post by ogd »

dbr wrote:
rgs92 wrote: 2. I have often heard that a large portion of long term equity returns come from dividends (with reinvesting, maybe over 70%, but I forgot the mentioned percentages).
This is true, but probably not as much as 50%. However it is a fallacy that stocks with higher dividend yield therefore have higher return.
Yes. The implicit comparison is not with stocks that retain dividends, but with stocks that pay dividends only to have them disappear into a black hole. Which would indeed underperform horribly.
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HomerJ
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Re: Why the popularity of dividends? What's the counterargum

Post by HomerJ »

Riprap wrote:Timely article. Total return vs. income and dividends in today's WSJ.

http://www.wsj.com/articles/whats-the-b ... 1426475052

Edited to add:
After reading the article, I would note that this discussion is several orders of magnitude better than the article. :oops:
From the article above:
When a company generates profits, it typically can do three things with the money: reinvest in its business, buy back shares or pay a dividend.
Or... 4th thing... Give the CEO a big fat bonus.

I don't really trust large established companies to "re-invest in the business"... New young companies, still growing, still run by the founder... sure... Old companies, run by some suit who didn't build the company, but showed up to "manage" AFTER all the building was done... I don't trust that guy nearly as much... Give me my dividend.
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Re: Why the popularity of dividends? What's the counterargum

Post by ralph124cf »

Dividends are one reason that I prefer to hold dividend stocks in taxable instead of tax deferred accounts. In taxable the dividend is taxed at 15%, but the tax deferred account changes that to my full marginal tax rate. I am currently drawing from my tax deferred accounts, my answer would have been different in the accumulation phase.

Ralph
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Re: Why the popularity of dividends? What's the counterargum

Post by hoops777 »

Iper.... I never said dividend mantra did not do research.I said from what I read on the site it all came across as a way to invest that seemingly had no downside.It will always end up rainbows and ice cream and his 200,000 will be a million before his ice cream melts.I must have read comments from over 30 followers and that is what struck me.I did not spend an hour there delving deep into his method but it just struck me as almost like a cult to be honest.Maybe that is where mantra comes in :D
Anyone who is 28,has between 100 and 200 thousand invested,makes 40k a year and expects to retire in 12 years at 40 and live off his dividend income,is a little bit too optimistic and living in la la land.Sorry.
Last edited by hoops777 on Mon Mar 16, 2015 6:59 pm, edited 1 time in total.
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Re: Why the popularity of dividends? What's the counterargum

Post by itstoomuch »

I rather take the market risk in the stock AND collect a dividend to compensate for the risk to own company.

We try to keep a minimal amount in FDIC accounts because of the insurance assessment.
We try to keep a minimum in bonds.
Divs have the approval of the Board of directors. And in the case of public_regulated utilities, the state's regulatory commission.
YMMV :annoyed
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