Risk in a high dividend stock portfolio

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Details
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Risk in a high dividend stock portfolio

Post by Details »

Hi all,
I'm a few years (2 to 5) until retirement, I'm wondering about high dividend stocks.
Looking at the site,
http://www.dividend.com/dividend-stocks ... stocks.php
and eliminating say the first 12, just because the dividend is so high you will
see 80 stocks paying between 15.69% and 8%. If you did some reasearch and
removed say 30 stocks that are poorer rated, that gives you 50 stocks with
an average 10% yield. You have some diversification (to be determined) and
possible stock price appreciation.
Has anyone looked at this as a retirement portfolio?
Is this just a stupid idea, or reasonable for 50% of a portfolio.
Just kicking an idea around, looking for input.

Thanks, Mikek
mhalley
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Re: Risk in a high dividend stock portfolio

Post by mhalley »

Those stocks will be WAAAY more risky than a normal stock fund. What is the average dividend on dividend type stock funds? Is it anywhere close to 10%? NO. 7%? NO. then surely it must be at least 5% right? Right? nope.
You might consider a portion of your portfolio in something like this, but if you put all your stock portfolio in this you are courting disaster. Just my opinion.
Mike
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Re: Risk in a high dividend stock portfolio

Post by madbrain »

It's a really stupid idea.
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Re: Risk in a high dividend stock portfolio

Post by Johm221122 »

Here is the question I'd ask myself, why isn't everyone taking advantage of these great dividends?

John
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Re: Risk in a high dividend stock portfolio

Post by larryswedroe »

First, high dividend paying stocks are not in any way substitutes for safe bonds.
Second, they USED to be value stocks, but the worst value strategy in terms of returns
Third, they are no longer value stocks due to POPULARITY, caused by the Fed's ZRP, along with anything with yield. So now their expected returns are perhaps even below market's expected returns.
Larry
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Re: Risk in a high dividend stock portfolio

Post by z3r0c00l »

Go to page 8 to find companies even close to safe, and of course by then they are only offering 6%, a return you could hope to get from a total stock market mutual fund. If you really want to do this, I would pick as many stocks as possible between page 8 and 14 including a few like AT&T, Mattel, or GlaxoSmithKline that make me much less nervous. Still, you can own all of these major stocks and then own all the rest in a diversified total stock index.
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Re: Risk in a high dividend stock portfolio

Post by nisiprius »

Qmavam wrote:Hi all,
I'm a few years (2 to 5) until retirement, I'm wondering about high dividend stocks.
Looking at the site,
http://www.dividend.com/dividend-stocks ... stocks.php
and eliminating say the first 12, just because the dividend is so high you will
see 80 stocks paying between 15.69% and 8%. If you did some reasearch and
removed say 30 stocks that are poorer rated, that gives you 50 stocks with
an average 10% yield. You have some diversification (to be determined) and
possible stock price appreciation.
Has anyone looked at this as a retirement portfolio?
Is this just a stupid idea, or reasonable for 50% of a portfolio.
Just kicking an idea around, looking for input.

Thanks, Mikek
It probably isn't going to ruin your financial life, but I don't think to be any better than total market index fund except by luck.

The soft spot in your idea is "if you did some reasearch and removed say 30 stocks that are poorer rated." Either you believe in stock-picking, or you don't. If I thought "ratings" were actually reliable guides to future performance then of course I would not invest in index funds--why invest in the total market, good and bad stocks alike, why not use "ratings" and only invest in the good ones?

To add to what others have said: money is money, a company can either keep it or pay it out. If they pay it out, they now have less. That means that if a company pays out dividends, the market judges that the total value of the company has just gone down by the amount they paid out. We see this clearly in the prices of individual stocks, which go down the day after a dividend is paid.

If we assume that the only difference between company A and company B is that A chooses to pay out higher dividends, then the two company's stocks are equally good. There should be no financial difference between spending the $1,000 of dividends from company A, and selling $1,000 of company B's stock and spending that. Or, if we are accumulating, there should be no financial difference between reinvesting all the dividends from company A and buying a larger number of shares. There's no magic. Company A pays out more, but grows more slowly.

There is actually a theorem in economics, the Modigliani–Miller theorem, which I've heard of but don't understand myself, which says something like what I just said.

In order to believe in "dividend stocks" as being a better financial strategy, in any important way, you need to believe some things that are questionable.

A) Dividend stock advocates sometimes argue that dividends are a numerical guide to something about the quality of management; keeps them honest, proves they have integrity, or whatever. On this theory, dividend stocks as a class are just plain better stocks from better companies. This theory is probably nonsense, because even if they really are better companies, investors know this, bid up the price, and so they may be better companies but no longer have better stocks.

B) On close inspection, most dividend stock advocates acknowledge point A, and "dividend stocks" is usually coupled with an very important qualifer: "On, of course we didn't mean you could just buy a (yecch) dividend stock index fund, because many dividend stocks are overvalued. We meant a portfolio of individual dividend stocks--just the good ones. Oh, and by the way, I publish a newsletter that will tell you which are good buys and which are overvalued."

So in fact, the "dividend stock" stuff is a red herring. The magic is knowing which dividend stocks to pick. In your own example, you suggest "removing say 30 stocks that are poorer rated." Well, either you believe in stock-picking or you don't. I don't. If "bad ratings" predicted bad future performance and "good ratings" predicted good performance we could all be rich--we'd just invest in the good stocks and not the bad ones.

If the strategy is actually "invest in dividend stocks, but of course only the good ones," I don't believe it's easy to pick stocks, so in order to accept that strategy I would want to know why it is easier to identify the good stocks among dividend stocks than it is among any other kind.

C) The only thing about dividend stocks that does make a tiny, limited amount of sense to me is behavioral. Many of us are coping with the idea of how to judge safe withdrawal rates in retirement. I don't want to open that can of worms fully, but many of us in retirement want to have a way to make withdrawals from our stock portfolio that are reasonably sustainable. Various rules have been proposed. We all know that if you withdraw too much now you will run short later, and we all know that the stock market fluctuates and it's a real puzzle to know what we can count in in the future. The Vanguard Managed Payout funds are an example of a fund that invests in an aggressive, actively managed portfolio, and calculates an amount to pay out. Whether it works or not, it is behaviorally useful to have someone else make a decision for you, hand you some number of dollars every month, and it's up to you to live within that amount.

"Invest in high-dividend stocks and use the dividends as your 'safe' withdrawals" is another example of a behaviorally convenient situation. Someone else decides how much to pay you, you then live within that amount.

I think it is delusional to suppose that this is magically any better or safer than any of dozens of other withdrawal systems. Company executives don't have any crystal balls and are only guessing at how much they can "afford" to pay in dividends. It is not necessarily safe--during the Great Depression many families who were, in fact, living off of stock dividends saw those dividends be cut or eliminated. But it is nevertheless one system.
Last edited by nisiprius on Tue Oct 21, 2014 8:22 am, edited 3 times in total.
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Re: Risk in a high dividend stock portfolio

Post by nisiprius »

P.S. I am wondering... are there any examples of companies that have chosen to issue two classes of stock, one which pays dividends and one which doesn't? It would be a great real-world test of whether the market believes the Modigliani–Miller theorem.
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Re: Risk in a high dividend stock portfolio

Post by nisiprius »

Dividend stock enthusiasts quibble about this--crushing arguments never actually crush anyone--but I still think the crushing argument is a comparison of the total return growth charts of dividend-oriented stock funds versus others.

For example, the Vanguard Equity Income fund, VEIPX, blue (actively managed) is specifically designed to produce income from a stock portfolio, and it was recommended by name by Burton Malkiel and Charles D. Ellis as part of a proposed "surrogate bond portfolio" strategy. '

Because Vanguard Equity Income (blue) is an actively managed fund with a "large value" style, I compared it to another Vanguard fund with a "large value" style, Vanguard Value Index, VIVAX, orange.

Source
Image

The curves are similar. (Yes, VEIPX did better). Notice in particular that there is no obvious "downside protection" in the dividend fund, no obvious difference in risk, VEIPX does not behave the way a bond fund or even a balanced fund would behave. This shows that:

--investor A used the Vanguard Equity Income fund (blue) and spent the dividends, while
--investor B used the Value Index fund (orange), and every month sold enough of the fund to raise exactly the same total amount of money, dividends + capital, as investor A received,

the results would have been similar. That is to say, there would have been little difference between receiving actual dividends and manufacturing a pseudo-dividend by selling shares.

The price (NAV in the case of VEIPX) are not similar at all. The two funds got similar total returns but they got them in different ways. VEIPX got more of it from dividends, VIVAX more of it from capital appreciation.

Image
Last edited by nisiprius on Tue Oct 21, 2014 12:48 pm, edited 1 time in total.
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Re: Risk in a high dividend stock portfolio

Post by Stryker »

Qmavam wrote:Hi all,
I'm a few years (2 to 5) until retirement, I'm wondering about high dividend stocks.
Looking at the site,
http://www.dividend.com/dividend-stocks ... stocks.php
and eliminating say the first 12, just because the dividend is so high you will
see 80 stocks paying between 15.69% and 8%. If you did some reasearch and
removed say 30 stocks that are poorer rated, that gives you 50 stocks with
an average 10% yield. You have some diversification (to be determined) and
possible stock price appreciation.
Has anyone looked at this as a retirement portfolio?
Is this just a stupid idea, or reasonable for 50% of a portfolio.
Just kicking an idea around, looking for input.

Thanks, Mikek
Personally, I think it would be highly risky to start learning about investing in individual equities when you're only two or three years away from retirement. I mean I invest in individual dividend (low yield) stocks myself alongside broad based index funds and ETF's in retirement, but after over thirty years of investing trying various strategies, I'm used to the inevitable disappointments along the way.
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Re: Risk in a high dividend stock portfolio

Post by Clive »

nisiprius wrote:If we assume that the only difference between company A and company B is that A chooses to pay out higher dividends, then the two company's stocks are equally good. There should be no financial difference between spending the $1,000 of dividends from company A, and selling $1,000 of company B's stock and spending that. Or, if we are accumulating, there should be no financial difference between reinvesting all the dividends from company A and buying a larger number of shares. There's no magic. Company A pays out more, but grows more slowly.
Stock goes x-div and the share price drops in reflection of the dividend amount. The share price then subsequently has a small positive bias up towards the next x-dividend date in reflection of the next dividend value amount. By the time the pay date comes around (one, two or more weeks after the x-div date) and the investor actually receives the money and perhaps pays fees to reinvest the dividend the share price would have appreciated (all else being equal) a little. Banks like dividends as they have all of that 'free' cash in their hand between x-div and pay dates. Brokers like dividends as they benefit from reinvestment fees. Market makers like dividends for similar reasons. The tax-man likes dividends as that's a up-front tax event rather than a deferred tax event. Investors should dislike dividends for all of the above reasons - preferring to defer taxes, reduce costs and create their own synthetic dividends (sell some shares) as and when they prefer to the amount they desire rather than having that dictated to them.

$60 trillion or whatever the global market cap is, 3% average dividend yield perhaps, three weeks between x-div and pay dates and that's $1.8T of idle/free money for 3 weeks ($104B/year pro-rata).
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Re: Risk in a high dividend stock portfolio

Post by Dandy »

So why would a stock that had a decent level of risk pay a 10% dividend? If it had any growth prospects it would be trying to conserve money for investing in the company. It might pay a dividend of a few percent but 10%? Not likely.

When dividends are that out of the normal range - stay away

By the way you may be a little late to the high dividend stock party. Interest rates have been low for many years and my guess is that
good stocks/funds paying good dividends have been bid up a bit.

VG High Dividend yield index fund is currently yielding just under 3% and their Value Index is about 2.5%. So, you might find a decent stock paying a bit more than those yields.
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Re: Risk in a high dividend stock portfolio

Post by DonCamillo »

I bought Wachovia on the day Bear Stearns collapsed. Tried to take advantage of a buying opportunity, low price, and a 10% yield. A little while later I had my shares converted into Wells Fargo stock at a cost of $140 a share. If I had bought Wells Fargo instead, I would have had seven times as many shares. My loss was not life-changing, with less than 1% of my assets in the gamble, but that was one of the events that led to appreciating Bogleheads.

My father put most of his money in three to five year CDs in those days. He would search the newspapers for high coupon CD offers. Interest rate offered was a terrific way to predict which banks would fail. I think he had CDs from 14 banks, and 11 of them had new names when I cashed in the CDs.

High Yield = High Risk
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Re: Risk in a high dividend stock portfolio

Post by leonard »

There are millions of "strategies" out there.

You're on the bogleheads website - instead of the question "how about (random) strategy X?" go ahead and spend the time setting up a low cost, index fund based Asset Allocation and a plan for rebalancing periodically.

Leave the dividend stock picking to the gamblers.
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Re: Risk in a high dividend stock portfolio

Post by Grt2bOutdoors »

Qmavam wrote:Hi all,
I'm a few years (2 to 5) until retirement, I'm wondering about high dividend stocks.
Looking at the site,
http://www.dividend.com/dividend-stocks ... stocks.php
and eliminating say the first 12, just because the dividend is so high you will
see 80 stocks paying between 15.69% and 8%. If you did some reasearch and
removed say 30 stocks that are poorer rated, that gives you 50 stocks with
an average 10% yield. You have some diversification (to be determined) and
possible stock price appreciation.
Has anyone looked at this as a retirement portfolio?
Is this just a stupid idea, or reasonable for 50% of a portfolio.
Just kicking an idea around, looking for input.

Thanks, Mikek
Can you retire with 50% of your current portfolio? If not, you would be best advised not to commit 50% or even 1% of your portfolio to such a strategy. If low volatility (low beta), large moat (read: large cap, well capitalized, low debt to equity, high return on equity and asset) type companies are paying at best - 2-3% in cash dividends but true shareholder free cash flow yields are closer to 5-7% when you account for common share buybacks net of stock dilution for management compensation, then please tell me why you would consider speculating on companies that pay out 10% but do not share in any of the features I've just described above? Far better to own a diversified portfolio of equities (domestic and international, large, mid and small) and a total bond market portfolio in an allocation that permits you to sleep at night - 100% equity is too risky, 100% bond is too risky as well, but perhaps a porridge of 60/40 or 50/50 will allow you to create a suitable total return portfolio at low cost and lower risk than that of just 50 "unreliable and unproven" horses amongst a field of over 5,700 different equities and over 3,000 individual fixed income securities. Good Luck! If you want to place a bet - the Powerball is currently at $100MM, otherwise don't gamble with money you can't afford to lose.

BTW, read those Larry Swedroe articles - they will help you in "keeping" your portfolio intact by not undertaking foolish risk.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
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Re: Risk in a high dividend stock portfolio

Post by FinancialDave »

Stryker wrote:
Qmavam wrote:Hi all,
I'm a few years (2 to 5) until retirement, I'm wondering about high dividend stocks.
Looking at the site,
http://www.dividend.com/dividend-stocks ... stocks.php
and eliminating say the first 12, just because the dividend is so high you will
see 80 stocks paying between 15.69% and 8%. If you did some reasearch and
removed say 30 stocks that are poorer rated, that gives you 50 stocks with
an average 10% yield. You have some diversification (to be determined) and
possible stock price appreciation.
Has anyone looked at this as a retirement portfolio?
Is this just a stupid idea, or reasonable for 50% of a portfolio.
Just kicking an idea around, looking for input.

Thanks, Mikek
Personally, I think it would be highly risky to start learning about investing in individual equities when you're only two or three years away from retirement. I mean I invest in individual dividend (low yield) stocks myself alongside broad based index funds and ETF's in retirement, but after over thirty years of investing trying various strategies, I'm used to the inevitable disappointments along the way.
Stryker,
You saved me some typing, as this is my view as well. My only difference is I use all dividend income for my retirement income, but I have about another 60% of my portfolio in growth stocks/funds, that I can pick from for "one-off" expenses. I was quite happy over the last two weeks when portions of the market were down by close to 10% as this doesn't affect my income at all. I also have no misconceptions that this would be a good growth strategy, or maybe even the best long term withdraw strategy, but it works for me.

fd
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Re: Risk in a high dividend stock portfolio

Post by SpaceCommander »

FWIW, I think that this approach is way too risky. Investing in a company (or 50 companies) just because they have high dividends is a recipe for regret. If you're going to buy a "dividend stock", it's usually a much better bet to purchase a blue chip with solid fundamentals. And diversify widely. Better to get the return OF your money than shoot for a return ON your money. In any case, the amount of the dividend is a secondary concern. However, this approach is not preferred on this board, so I wouldn't expect much encouragement here. I think it's possible to put together a solid portfolio of 20-30 dividend aristocrats and arrange a 4% dividend or so. Usually shooting for much more invites trouble. Still: a simpler approach might be to implement the 3 fund portfolio here and just arrange for a 4% annual withdrawal. It's clearly more diversified and likely more profitable over the long run. :beer
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Re: Risk in a high dividend stock portfolio

Post by Stryker »

FinancialDave wrote:
Stryker wrote:

Personally, I think it would be highly risky to start learning about investing in individual equities when you're only two or three years away from retirement. I mean I invest in individual dividend (low yield) stocks myself alongside broad based index funds and ETF's in retirement, but after over thirty years of investing trying various strategies, I'm used to the inevitable disappointments along the way.
Stryker,
You saved me some typing, as this is my view as well. My only difference is I use all dividend income for my retirement income, but I have about another 60% of my portfolio in growth stocks/funds, that I can pick from for "one-off" expenses. I was quite happy over the last two weeks when portions of the market were down by close to 10% as this doesn't affect my income at all. I also have no misconceptions that this would be a good growth strategy, or maybe even the best long term withdraw strategy, but it works for me.

fd
FinancialDave:

I think that's a very important point. Whatever works for the investor. That's all that matters. I find that over time, the more you learn, the fewer mistakes made in the portfolio.
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Re: Risk in a high dividend stock portfolio

Post by grabiner »

nisiprius wrote:The price (NAV in the case of VEIPX) are not similar at all. The two funds got similar total returns but they got them in different ways. VEIPX got more of it from dividends, VIVAX more of it from capital appreciation.

Image
I don't think this is actually what is going on. VEIPX, as an actively managed fund, frequently distributes capital gains, which reduce the share price by an amount equal to the dividend but do not represent dividends. VIVAX distributed some capital gains as well before it added an ETF class. Note, for example, December 1998-January 1999, December 2004-January 2005 (both crossing lines in the graph) and December 1993-January 1994 and December 2005-January 2006 (not crossing lines), when VIVAX's price rose and VEIPX's price fell. In bear markets, and following the 2007-2009 market drop when there were capital losses to offset future gains, the NAVs tracked very well.
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