Help me understand dividends

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rbaldini
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Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 8:12 pm

My understanding is that in stock funds, the dividend has no effect on the amount of money I have. E.g., if VTSMX gives me a $0.25/share dividend, then I "get" $0.25 per share that I hold... but the value of the shares also drops $0.25, so my total wealth doesn't move at all.

Is this right? If it is, why should I care *at all* about dividends? Please help.

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grabiner
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Re: Help me understand dividends

Post by grabiner » Tue Nov 01, 2016 8:28 pm

In a taxable account (as opposed to a tax-sheltered account such as an IRA or 401(k)), the reason dividends matter is that you pay tax on them. If your $10,000 mutual fund investment pays a $200 dividend as its value decreases to $9800, you haven't gained or lost any money (and you could reinvest that dividend to keep $10,000 in the mutual fund), but you will owe tax on that $200.
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rbaldini
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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 8:30 pm

grabiner wrote:In a taxable account (as opposed to a tax-sheltered account such as an IRA or 401(k)), the reason dividends matter is that you pay tax on them. If your $10,000 mutual fund investment pays a $200 dividend as its value decreases to $9800, you haven't gained or lost any money (and you could reinvest that dividend to keep $10,000 in the mutual fund), but you will owe tax on that $200.
So... dividends are bad.

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grabiner
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Re: Help me understand dividends

Post by grabiner » Tue Nov 01, 2016 8:43 pm

rbaldini wrote:
grabiner wrote:In a taxable account (as opposed to a tax-sheltered account such as an IRA or 401(k)), the reason dividends matter is that you pay tax on them. If your $10,000 mutual fund investment pays a $200 dividend as its value decreases to $9800, you haven't gained or lost any money (and you could reinvest that dividend to keep $10,000 in the mutual fund), but you will owe tax on that $200.
So... dividends are bad.
They are costly in a taxable account; however, they are an unavoidable part of investing. Stocks pay dividends, and funds holding them are required to distribute the dividends to shareholders.

There are some things you can do to minimize the effect. Choose funds which have lower distributions, both of dividends and capital gains, in your taxable account. This usually means stock index funds, with blend indexes (such as a total-market index) better than value indexes.
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Re: Help me understand dividends

Post by qwertyjazz » Tue Nov 01, 2016 9:03 pm

Complicated
A stock price is the future expected value of the xompany. So it is not only the dividend monetary value but what it signals to perspective buyers. It could mean relative company health. There are also investors who tend to by dividend stocks. There are also those who prefer growth companies so a 1 dollar dividend can move the price more or less than a dollar depending on its signaling component.
Also there is the theoretical construct of there might not be a stock market if dividend as a concept in some future time does not exist (although that does not mean that you necessarily want it any time in the near future)
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alex_686
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Re: Help me understand dividends

Post by alex_686 » Tue Nov 01, 2016 9:06 pm

rbaldini wrote:So... dividends are bad.
Dividends are complex.

Theory states that there are no first order affects of dividends. For this to be true you have to make lots of assumptions. Taxes are one. Investment opportunities are another. You don't want management investing the profits into cash, white elephants, or marginal ventures.

There are second order affects.

The only value a stock has is its discounted future cash flow. One might be indifferent to a bird in hand (dividends) or two in the bush (reinvesting the profits) in the short run, but at some point the owners will cash flowing to them. Dividends is the classic way of doing this. Stock buy backs are another.

Lastly, management can use dividends as a signal of solid earnings. Investors irrationally don't like dividends being cut. Investors will pay more for a company with high quality earnings against a company that has uncertain earnings. This shows up in the P/E ratio.

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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 9:11 pm

alex_686 wrote:
rbaldini wrote:So... dividends are bad.
Dividends are complex.

Theory states that there are no first order affects of dividends. For this to be true you have to make lots of assumptions. Taxes are one. Investment opportunities are another. You don't want management investing the profits into cash, white elephants, or marginal ventures.

There are second order affects.

The only value a stock has is its discounted future cash flow. One might be indifferent to a bird in hand (dividends) or two in the bush (reinvesting the profits) in the short run, but at some point the owners will cash flowing to them. Dividends is the classic way of doing this. Stock buy backs are another.

Lastly, management can use dividends as a signal of solid earnings. Investors irrationally don't like dividends being cut. Investors will pay more for a company with high quality earnings against a company that has uncertain earnings. This shows up in the P/E ratio.
All this complexity aside:
I buy stocks so that I can ultimately have more money. When I "receive" a dividend, I have not made more money. Instead, my tax burden has increased. So why as an investor should I want to receive dividends?

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Re: Help me understand dividends

Post by bamn » Tue Nov 01, 2016 9:13 pm

At the risk of stating the obvious, the reason fund values drop after paying a dividend is such: if they didn't, you could buy a fund right before it was due to pay a dividend, then sell it for the same price immediately after, to get free money. I picture a fund swelling slowly as a dividend becomes due, then shedding it like a chicken might lay an egg.

Given that dividends are the mechanism by which companies give their owners the profits, I also find it odd to think about a world without dividends. What would be the point of owning a company if it was sure to never pay you? Could you even count on capital appreciation of the shares, since there'd be no basis for speculation?

rbaldini
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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 9:15 pm

bamn wrote:Given that dividends are the mechanism by which companies give their owners the profits, I also find it odd to think about a world without dividends. What would be the point of owning a company if it was sure to never pay you? Could you even count on capital appreciation of the shares, since there'd be no basis for speculation?
I'm taking the investor's perspective. Why should I, an investor, care about receiving dividends, when they do not increase my wealth but do increase my tax burden? Am I missing something?

GuitarXM
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Re: Help me understand dividends

Post by GuitarXM » Tue Nov 01, 2016 9:17 pm

rbaldini wrote:My understanding is that in stock funds, the dividend has no effect on the amount of money I have. E.g., if VTSMX gives me a $0.25/share dividend, then I "get" $0.25 per share that I hold... but the value of the shares also drops $0.25, so my total wealth doesn't move at all.

Is this right? If it is, why should I care *at all* about dividends? Please help.
I was also confused by this at first. Other than the taxes discussed above, Dividends are a good thing and your wealth increases.
This should help you out from investopedia.com

"The declaration of a dividend naturally encourages investors to purchase stock. Because investors know that they will receive a dividend if they purchase the stock before the ex-dividend date, they are willing to pay a premium. This causes the price of stock to increase in the days leading up to the ex-dividend date. In general, the increase is about equal to the amount of the dividend, but the actual price change is based on market activity and not determined by any governing entity.

On the ex-dividend date, the exchange reduces the stock price by the amount of the dividend to account for the fact that new investors are not eligible to receive dividends and are therefore unwilling to pay a premium. However, if the market is particularly optimistic about the stock leading up to the ex-dividend date, the price increase this creates may be larger than the actual dividend amount, resulting in a net increase despite the automatic reduction. If the dividend is small, the reduction may even go unnoticed due to the back and forth of normal trading."

Basically what they are saying is that the market accounts for the dividend.
Example:

Stock price $1
The company announces a dividend of 10 cents.
I'm not sure on all the mechanics, because there is declaration date, ex- dividend date, date of record, payment date.
The price of stock goes to $0.90 and you have your 10 cent dividend which you can do whatever you want with.
As the next dividend approaches, the 90 cent stock approaches $1 because people are expecting that 10 cent dividend again.
If you buy the stock before the ex-dividend date you still get the dividend but the market price reduces by same amount after that.
So you can't just buy and sell stocks and pocket the dividend right before and after the ex-dividend date.

Its a slow process but that's how it works. Dividends are usually paid 4 times a year so when you get your dividend expect the price to go up slowly until the next dividend date. Of course there are other things that will influence the stock price but that's the main idea...

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morbster
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Re: Help me understand dividends

Post by morbster » Tue Nov 01, 2016 9:20 pm

rbaldini wrote:I'm taking the investor's perspective. Why should I, an investor, care about receiving dividends, when they do not increase my wealth but do increase my tax burden? Am I missing something?
Investors view it as diminished risk. If you're investing in the future value of a company by purchasing shares, wouldn't it be nice to have at least some form of "certain" return? (Note that I do not totally agree with this premise, but I believe that's a fairly common perspective for dividend proponents.)

rbaldini
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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 9:26 pm

GuitarXM wrote: Stock price $1
The company announces a dividend of 10 cents.
I'm not sure on all the mechanics, because there is declaration date, ex- dividend date, date of record, payment date.
The price of stock goes to $0.90 and you have your 10 cent dividend which you can do whatever you want with.
As the next dividend approaches, the 90 cent stock approaches $1 because people are expecting that 10 cent dividend again.
If you buy the stock before the ex-dividend date you still get the dividend but the market price reduces by same amount after that.
So you can't just buy and sell stocks and pocket the dividend right before and after the ex-dividend date.

Its a slow process but that's how it works. Dividends are usually paid 4 times a year so when you get your dividend expect the price to go up slowly until the next dividend date. Of course there are other things that will influence the stock price but that's the main idea...
If I'm understanding you correctly, then dividends themselves are of no direct worth. Rather, their value is that they cause price to rise by encouraging people to buy (though, why should they? they get nothing by buying prior to a dividend); this price increase is where you actually make your money. If this is true, then shouldn't dividend-paying stocks show greater price growth (apart from the dividend price drops) than non-dividend-paying stock? And if that were true, wouldn't investors have figured this all out by now?
Last edited by rbaldini on Tue Nov 01, 2016 9:30 pm, edited 1 time in total.

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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 9:28 pm

morbster wrote:
rbaldini wrote:I'm taking the investor's perspective. Why should I, an investor, care about receiving dividends, when they do not increase my wealth but do increase my tax burden? Am I missing something?
Investors view it as diminished risk. If you're investing in the future value of a company by purchasing shares, wouldn't it be nice to have at least some form of "certain" return? (Note that I do not totally agree with this premise, but I believe that's a fairly common perspective for dividend proponents.)
Indeed, I do not understand this at all. When I receive a dividend, I have received *nothing* (well, more taxes). What is the "certain return"?

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Re: Help me understand dividends

Post by DSInvestor » Tue Nov 01, 2016 9:34 pm

Mutual funds receive dividends from the underlying holdings. The Net Asset Value (NAV) of the fund published each trading day represents the value of the fund's holdings including dividends minus expenses. The accumulated dividends are paid out to shareholders on the distribution date which reduces the net worth of the fund thus causing a reduction in the Net Asset Value. If you sell fund shares before the distribution date, you haven't lost out on the dividend because the NAV includes any accumulated dividends to date. You get to sell shares at a slightly higher price/NAV because of those accumulated dividends.

Total return = capital return (change in value of the fund) + income return (dividends).

Here's a link to Vanguard page showing you the Total return, capital return and income return for Total Stock Market.
https://personal.vanguard.com/us/funds/ ... INT#tab=1a

Here's a link to a similar page for Vanguard Total Bond Market Index:
https://personal.vanguard.com/us/funds/ ... INT#tab=1a

You may notice that income return makes up a large portion of the Total Return for Total Bond Market but only a small portion of the total return for Total Stock Market.
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rbaldini
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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 9:39 pm

DSInvestor wrote:Mutual funds receive dividends from the underlying holdings. The Net Asset Value (NAV) of the fund published each trading day represents the value of the fund's holdings including dividends minus expenses. The accumulated dividends are paid out to shareholders on the distribution date which reduces the net worth of the fund thus causing a reduction in the Net Asset Value. If you sell fund shares before the distribution date, you haven't lost out on the dividend because the NAV includes any accumulated dividends to date. You get to sell shares at a slightly higher price/NAV because of those accumulated dividends.

Total return = capital return (change in value of the fund) + income return (dividends).

Here's a link to Vanguard page showing you the Total return, capital return and income return for Total Stock Market.
https://personal.vanguard.com/us/funds/ ... INT#tab=1a
I'm guessing "income return" is the amount paid by dividends. Suppose I received 2% in dividends. Didn't this also reduce my capital return by 2%, yielding no effect? I.e. they might as well have not paid the 2% dividend; I would have had a 2% greater capital return. Is this right?

GuitarXM
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Re: Help me understand dividends

Post by GuitarXM » Tue Nov 01, 2016 9:39 pm

I'm no expert on this subject because I'm still learning just like you.

So here is how it works....
As Bogle shows, long term, stock price follows Earnings growth.

There are stocks which pay dividends and other don't. All depends on the board of the company.
Stocks that pay dividends give you the money and let you do what you want with it.
Stocks that don't pay dividends keep all the money and reinvest it in the company.

You make money when your stock price goes up which follows earnings.
So say the company makes $100. They decide to give you $10 and keep $90 and reinvest it in the company by basically promising you future earnings increases. If the company pays you $10, they have now $90 to increase future earnings. If the company pays you nothing then they reinvest the entire $100 into the company. So the question is who can manage the money better? You or the Company?

And this is where growth stocks vs value stocks battle begins. Growth stocks usually are newer companies that don't pay any dividends. They reinvest all the money because they think they can grow and increase earnings. Value companies are usually mature companies that are so big that they can't grow any more, so they decide to give you some of the money as dividend because they know they can't increase earnings as much as before when they were new growing companies.

At the end of the day its the price of the stock that matters to you and you have to remember that price follows earnings long term.
Dividends are a tiny percentage of the stock increase/decrease. Its the earnings that count. There are many other things to affect prices such as speculation and many other things.

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Re: Help me understand dividends

Post by GuitarXM » Tue Nov 01, 2016 9:45 pm

rbaldini wrote:
DSInvestor wrote:Mutual funds receive dividends from the underlying holdings. The Net Asset Value (NAV) of the fund published each trading day represents the value of the fund's holdings including dividends minus expenses. The accumulated dividends are paid out to shareholders on the distribution date which reduces the net worth of the fund thus causing a reduction in the Net Asset Value. If you sell fund shares before the distribution date, you haven't lost out on the dividend because the NAV includes any accumulated dividends to date. You get to sell shares at a slightly higher price/NAV because of those accumulated dividends.

Total return = capital return (change in value of the fund) + income return (dividends).

Here's a link to Vanguard page showing you the Total return, capital return and income return for Total Stock Market.
https://personal.vanguard.com/us/funds/ ... INT#tab=1a
I'm guessing "income return" is the amount paid by dividends. Suppose I received 2% in dividends. Didn't this also reduce my capital return by 2%, yielding no effect? I.e. they might as well have not paid the 2% dividend; I would have had a 2% greater capital return. Is this right?
The capital return wasn't reduced.
When you get that 2% dividend, yes the price reduces by 2%, but keep in mind that the stock price will go up as it approaches next dividend.
So you didn't lose anything in the price of the stock and gained a 2% dividend. Do you get it now?

learning_head
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Re: Help me understand dividends

Post by learning_head » Tue Nov 01, 2016 9:51 pm

rbaldini wrote:I'm taking the investor's perspective. Why should I, an investor, care about receiving dividends, when they do not increase my wealth but do increase my tax burden? Am I missing something?
I would guess most folks on this board would agree with you and do not care about dividends from a fund aside from potentially tax-related aspect. Not many people here invest in funds that seek out companies based on increased dividend policies. If anything, some may invest in tax-managed funds to minimize taxes for taxable accounts, if costs of such funds is low enough.

You may then ask why do any investors care about dividends? If they did not, companies would not need to pay them, right? I think others have some good responses already in their replies. Ultimately, when a given company is mature enough, its investors (i.e. owners) want it to return reasonable amount of profits back to them instead of investing in projects that are risky and unlikely to "move the needle" for the company. You, as an owner of a company, may want its value to be delivered to you in terms of periodic payments that you can reinvest as you see fit, whether it is into the same business or another one.

P.S. @GuitarXM: no, the price will not go up 2% necessarily. It depends on the business and the price may very well stay intrinsically the same or go down, etc.

rbaldini
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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 9:58 pm

GuitarXM wrote: The capital return wasn't reduced.
When you get that 2% dividend, yes the price reduces by 2%, but keep in mind that the stock price will go up as it approaches next dividend.
So you didn't lose anything in the price of the stock and gained a 2% dividend. Do you get it now?
I see that that is your argument, but I'm not yet convinced. I'd like to see it demonstrated. Are there any studies showing that, for example, the return of a fund after cutting its dividend is reduced by approximately that amount? I'm not convinced because I *know* that the price drops immediately after receiving a dividend - I've seen it happen. I do *not* know that, without the dividend, the price wouldn't have increased as much as it did, which is what you are arguing.

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Re: Help me understand dividends

Post by triceratop » Tue Nov 01, 2016 10:07 pm

rbaldini wrote:
DSInvestor wrote:Mutual funds receive dividends from the underlying holdings. The Net Asset Value (NAV) of the fund published each trading day represents the value of the fund's holdings including dividends minus expenses. The accumulated dividends are paid out to shareholders on the distribution date which reduces the net worth of the fund thus causing a reduction in the Net Asset Value. If you sell fund shares before the distribution date, you haven't lost out on the dividend because the NAV includes any accumulated dividends to date. You get to sell shares at a slightly higher price/NAV because of those accumulated dividends.

Total return = capital return (change in value of the fund) + income return (dividends).

Here's a link to Vanguard page showing you the Total return, capital return and income return for Total Stock Market.
https://personal.vanguard.com/us/funds/ ... INT#tab=1a
I'm guessing "income return" is the amount paid by dividends. Suppose I received 2% in dividends. Didn't this also reduce my capital return by 2%, yielding no effect? I.e. they might as well have not paid the 2% dividend; I would have had a 2% greater capital return. Is this right?
Right, but doing the analysis of dividends only at this level ignores that if there were no dividends or return of equity to investors then there would be no point in investing. Yes, the tax burden is annoying.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

rbaldini
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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 10:50 pm

triceratop wrote: Right, but doing the analysis of dividends only at this level ignores that if there were no dividends or return of equity to investors then there would be no point in investing. Yes, the tax burden is annoying.
I don't see how this is true. If you sell something at a higher price than you paid for it, then it generated a return. This can happen for a stock even if it doesn't pay a dividend, no? Isn't this the primary way you make money when you invest in Vanguard total stock market index fund?

alex_686
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Re: Help me understand dividends

Post by alex_686 » Tue Nov 01, 2016 10:54 pm

rbaldini wrote:If I'm understanding you correctly, then dividends themselves are of no direct worth. Rather, their value is that they cause price to rise by encouraging people to buy (though, why should they? they get nothing by buying prior to a dividend); this price increase is where you actually make your money. If this is true, then shouldn't dividend-paying stocks show greater price growth (apart from the dividend price drops) than non-dividend-paying stock? And if that were true, wouldn't investors have figured this all out by now?
The value of a stock if the discounted (time value) free cash flow to the owner. This is why stocks have intrinsic value. It is what separates stocks from gold, tulips (See the great Tulip Bubble), or Bennie Babies (see the great Bennie Baby bubble). You don't have to wait for a greater fool to come in and buy your stock. One does have the option of just holding it and wait for the free cash flow. If not dividends, how do you expect to get your cash?

From a theoretical view it does not matter if the cash is returned by dividends or stock buy back. Go back to my earlier post on why it might make a psychological difference. I think if we go any further down this road we will start talking about how to construct a efficient tax policy and not about investing.
rbaldini wrote:Indeed, I do not understand this at all. When I receive a dividend, I have received *nothing* (well, more taxes). What is the "certain return"?
Which would you rather have, a bird in hand or 2 in the bush? The company has made a profit and there is cash on the books. Should the company give that cash back to its owners or should it reinvest those funds? Warren Buffet and Berkshire Hathaway have done well. Microsoft's investment in Nokia was a bust. Enron was a complete bust. Even if the odds are in your favor at some point you are going to want to take some chips off of the board in case the company totally collapses.

For a fun easy read on why you don't want companies to keep your money there is Barbarians at the Gate by Bryan Burrough and John Helyar.
rbaldini wrote:I see that that is your argument, but I'm not yet convinced. I'd like to see it demonstrated. Are there any studies showing that, for example, the return of a fund after cutting its dividend is reduced by approximately that amount? I'm not convinced because I *know* that the price drops immediately after receiving a dividend - I've seen it happen. I do *not* know that, without the dividend, the price wouldn't have increased as much as it did, which is what you are arguing.
I am not exactly sure what you are asking here because I think we are mixing a few concepts here like dividend policy verse earnings growth. I will point out that prices of forwards and options on indexes and individual stocks do reflect the ongoing accrual and paying of dividends. For a very technical book on the theory behind this checkout Continuous-Time Finance by Robert C. Merton. People have made real money using the arbitrage trades that this allows.

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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 11:06 pm

alex_686 wrote:From a theoretical view it does not matter if the cash is returned by dividends or stock buy back.
My argument is hardly theoretical. It's very simple: when I receive a dividend, I get no additional wealth. So why do I care about it? If I wanted cash instead of shares, I would have sold my shares. ???
alex_686 wrote: Which would you rather have, a bird in hand or 2 in the bush?
I don't really get this. Let's ask it this way: would you rather have
(1) $100 dollars spread across 10 shares
(2) $100 dollars spread across 11 shares (assuming you reinvest a dividend)
My answer is "I don't care".
alex_686 wrote:
rbaldini wrote:I see that that is your argument, but I'm not yet convinced. I'd like to see it demonstrated. Are there any studies showing that, for example, the return of a fund after cutting its dividend is reduced by approximately that amount? I'm not convinced because I *know* that the price drops immediately after receiving a dividend - I've seen it happen. I do *not* know that, without the dividend, the price wouldn't have increased as much as it did, which is what you are arguing.
I am not exactly sure what you are asking here because I think we are mixing a few concepts here like dividend policy verse earnings growth.
The point is that GuitarXM is claiming that the policy of dividends is partly what drives stock prices up. Suppose a fund pays a 2% dividend. I was arguing that if this fund didn't pay the 2% dividend, than their capital growth would just increase by exactly 2% (because then the dividend price cut wouldn't have happened), so there would be no effect on return. GuitarXM is arguing (I believe) that this is wrong: issuing dividends causes capital growth to be larger than it otherwise would be; the 2% wouldn't exactly cancel out.

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Re: Help me understand dividends

Post by DSInvestor » Tue Nov 01, 2016 11:19 pm

OP, have you ever generated charts at Morningstar.com? Give this a try.

At morningstar.com, search for Vanguard Equity Income VEIPX by entering either the fund name or ticker into the quote box. I picked this fund because I think it is a fund that pays a relatively high dividend. Click on the tab for "chart". The first chart you will see is a growth chart of a hypothetical investment over 10 years that includes dividend reinvestment. An investment of 10K into this fund would be worth about 19.9K today. The investment doubled in the last 10 years. You can move your mouse over the chart to see value on any day.

Now change the chart from growth chart to price chart. Look for the word growth on the upper left of the chart, click on price. NAV on 11/2/2006 was 25.74. NAV on 11/2/2016 was 31.14. The NAV of the fund increased by 20.9% in the last 10 years.

The difference between the growth chart and the price chart is the reinvestment of dividends. The price chart covers capital return whereas the growth chart covers total return which is capital return plus income return.

Dividends are an important component of Total Return but depending on where you hold the investments, the income return can cause extra taxation which is a drag on returns. This is why we try to suggest that investors consider tax efficiency when a portion of the portfolio is held in taxable accounts.
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Miriam2
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Re: Help me understand dividends

Post by Miriam2 » Tue Nov 01, 2016 11:29 pm

Here is another thread with plenty of good material to digest about dividends :happy

viewtopic.php?f=10&t=151795 - Why do we like dividends?

soboggled
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Re: Help me understand dividends

Post by soboggled » Tue Nov 01, 2016 11:30 pm

rbaldini wrote:
alex_686 wrote:From a theoretical view it does not matter if the cash is returned by dividends or stock buy back.
My argument is hardly theoretical. It's very simple: when I receive a dividend, I get no additional wealth. So why do I care about it? If I wanted cash instead of shares, I would have sold my shares. ???
alex_686 wrote: Which would you rather have, a bird in hand or 2 in the bush?
I don't really get this. Let's ask it this way: would you rather have
(1) $100 dollars spread across 10 shares
(2) $100 dollars spread across 11 shares (assuming you reinvest a dividend)
My answer is "I don't care".
alex_686 wrote:
rbaldini wrote:I see that that is your argument, but I'm not yet convinced. I'd like to see it demonstrated. Are there any studies showing that, for example, the return of a fund after cutting its dividend is reduced by approximately that amount? I'm not convinced because I *know* that the price drops immediately after receiving a dividend - I've seen it happen. I do *not* know that, without the dividend, the price wouldn't have increased as much as it did, which is what you are arguing.
I am not exactly sure what you are asking here because I think we are mixing a few concepts here like dividend policy verse earnings growth.
The point is that GuitarXM is claiming that the policy of dividends is partly what drives stock prices up. Suppose a fund pays a 2% dividend. I was arguing that if this fund didn't pay the 2% dividend, than their capital growth would just increase by exactly 2% (because then the dividend price cut wouldn't have happened), so there would be no effect on return. GuitarXM is arguing (I believe) that this is wrong: issuing dividends causes capital growth to be larger than it otherwise would be; the 2% wouldn't exactly cancel out.
You are quoting out of context/misinterpreting. You are either trolling or engineering schools don't teach logic anymore.

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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 11:31 pm

DSInvestor wrote:OP, have you ever generated charts at Morningstar.com? Give this a try.

At morningstar.com, search for Vanguard Equity Income VEIPX. I picked this fund because I think it is a fund that pays a relatively high dividend. Click on the tab for "chart". The first chart you will see is a growth chart of a hypothetical investment over 10 years that includes dividend reinvestment. An investment of 10K into this fund would be worth about 19.9K today. The investment doubled in the last 10 years.

Now change the chart from growth to price. Look for the word growth on the upper left of the chart. NAV on 11/2/2006 was 25.74. NAV on 11/2/2016 was 31.14. The NAV of the fund increased by 20.9% in the last 10 years.

The difference between the growth chart and the price chart is the reinvestment of dividends. The price chart covers capital return whereas the growth chart covers total return which is capital return plus income return.
I get it: reinvesting dividends makes you more money than not reinvesting them. That's not the point.

Consider this: when I receive a dividend and reinvest it, I have no more money than before. All that happens is that I have the same amount of money, but divided into more shares. Therefore the sum of all those dividends over time had no effect.

So imagine the counterfactual world where VEIPX did not pay dividends. How much would I have made? Well, since each divided had no effect, presumably I would have made exactly same amount (or close to it anyway). Another way to think of this is that the reason VEIPX capital returns are so small is *precisely because* it pays dividends, which reduce share price. (GuitarXM is arguing that the total return would be less.)

Do let me know if I'm got something wrong there.

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Re: Help me understand dividends

Post by rbaldini » Tue Nov 01, 2016 11:33 pm

soboggled wrote: You are quoting out of context/misinterpreting. You are either trolling or engineering schools don't teach logic anymore.
Enlighten me. Really.

Every time I get a dividend, the effect on my net worth is 0. Drawing on my knowledge of arithmetic, I conclude that the sum effect of all dividends over time is 0. I really, truly don't get it.

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Re: Help me understand dividends

Post by lack_ey » Tue Nov 01, 2016 11:51 pm

rbaldini wrote:
GuitarXM wrote: Stock price $1
The company announces a dividend of 10 cents.
I'm not sure on all the mechanics, because there is declaration date, ex- dividend date, date of record, payment date.
The price of stock goes to $0.90 and you have your 10 cent dividend which you can do whatever you want with.
As the next dividend approaches, the 90 cent stock approaches $1 because people are expecting that 10 cent dividend again.
If you buy the stock before the ex-dividend date you still get the dividend but the market price reduces by same amount after that.
So you can't just buy and sell stocks and pocket the dividend right before and after the ex-dividend date.

Its a slow process but that's how it works. Dividends are usually paid 4 times a year so when you get your dividend expect the price to go up slowly until the next dividend date. Of course there are other things that will influence the stock price but that's the main idea...
If I'm understanding you correctly, then dividends themselves are of no direct worth. Rather, their value is that they cause price to rise by encouraging people to buy (though, why should they? they get nothing by buying prior to a dividend); this price increase is where you actually make your money. If this is true, then shouldn't dividend-paying stocks show greater price growth (apart from the dividend price drops) than non-dividend-paying stock? And if that were true, wouldn't investors have figured this all out by now?
You're right to question that narrative, which doesn't make sense.

But for what it's worth, historically actually dividend-paying stocks have outperformed. This can be explained multiple ways, though mainly by noting that this resulted in an incidental tilt towards value stocks on average, which outperformed, delivering a higher total return than growth stocks (though not in the last 10 years, and plenty of other periods). That is, on average the lower-priced stocks relative to earnings/book value/etc. had the higher total returns—though also the higher tax burden from the typically higher dividends... though probably still higher return even after taxes. Some call this systemic underpricing on average, others a statistical fluke, others an explanation about risk (not all else equal) or something else.

rbaldini wrote:
alex_686 wrote:From a theoretical view it does not matter if the cash is returned by dividends or stock buy back.
My argument is hardly theoretical. It's very simple: when I receive a dividend, I get no additional wealth. So why do I care about it? If I wanted cash instead of shares, I would have sold my shares. ???
As an individual investor, all else equal (specifically, equal total returns) you should not want dividends because they increase your tax burden. That's right.

(But if dividend-paying stocks have a higher return or some better properties maybe you do actually want them.)

It used to be decades ago that trading stocks was very expensive compared to what it was today, and having dividend-paying stocks meant you could effectively "sell" a fraction of your investment regularly without paying the huge commissions to actually sell. So dividends were useful in that way.

And there's a good deal of tradition and historical significance around dividends, and expectations around dividends to this day. A lot of investors want dividends, for better or worse.

From a business/economic perspective, if companies have excess earnings they can't reinvest efficiently into their business (e.g. if they used the money to build a new factory to make more widgets the rate of return would be bad), you're better off if they actually pay dividends to you so you can reinvest that money yourself, rather than them sitting on lots of excess cash for no reason or them spending the money unwisely. Except actually, they can just buy back some stock with that money rather than pay a dividend, which won't increase your tax bill if you're not selling. That increases your ownership stake and more or less works the same as if they paid a dividend and you used that dividend to buy more stocks, except you don't need to pay taxes this way.

Note that taxation of dividends works differently in other countries and dividend payout rates are relatively low in the US in part probably because they're unfavorable from a tax perspective.

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Re: Help me understand dividends

Post by alex_686 » Wed Nov 02, 2016 12:24 am

Rbaldini, Are we talking about funds or are we talking about stocks?

If it is about mutual funds you are substantially right. If it is about stocks you are substantially wrong.

You have the "bird in hand" question wrong. Let us assume you have $1,000 invested in a company. It has a 99% chance of $100 in 1 year, or a 10% return. It has a 1% chance of going bankrupt where you get nothing. The company has just gone ex. Do you
(1) Take the $100 dividend (bird in hand) or
(2) Reinvest the dividend, hoping for a probably but uncertain higher return.

So I will ask you again, if not dividends how do you plan to get your cash? What makes stocks different from tulip bulbs or Beanie Babies? Won't these always trade higher?

Maybe your answer is stock buy backs. If so that just may be a debate on semantics. Same function, different form.

Maybe you answer is that you will sell you stock. If so let me inform you of the many practical ways that might not work. I will point to my book recommendation, "Barbarians at the Gate: The Fall of RJR Nabisco". You stock may have a book value of $100 but it is only selling for $70. Instead of paying dividend RJR invested in failing projects, corporate empire building, and flying the CEO's dog around in a private jet. The company was actively destroying shareholder value. If you were in that situation what are your options?

There are many ways that managers can abuse shareholders. Paying dividends is one way of limiting that abuse.

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Re: Help me understand dividends

Post by HomerJ » Wed Nov 02, 2016 1:00 am

rbaldini wrote:
morbster wrote:
rbaldini wrote:I'm taking the investor's perspective. Why should I, an investor, care about receiving dividends, when they do not increase my wealth but do increase my tax burden? Am I missing something?
Investors view it as diminished risk. If you're investing in the future value of a company by purchasing shares, wouldn't it be nice to have at least some form of "certain" return? (Note that I do not totally agree with this premise, but I believe that's a fairly common perspective for dividend proponents.)
Indeed, I do not understand this at all. When I receive a dividend, I have received *nothing* (well, more taxes). What is the "certain return"?
Stocks can go up AND down... Dividends can also be cut, but it's more rare. A 2% dividend means you're going to get that 2% return on your investment even if the stock drops a bit. (if the stocks drop a LOT, the dividend may also be cut, so nothing Is certain).

Look, stocks are part ownership in a company.

When stocks originally came out, the whole point of being a part-owner was to share in the profits.

You own 0.0003% of Coca-Cola, and every 3 months, you get 0.0003% of the profits as a dividend check.. That was the whole reason to own stocks. No one in the old days would buy a stock that didn't pay out part of the profits.

What I find far more ridiculous than dividends is this mindset:

"Hey, invest in my company! I'll never pay you a cent, but you can watch me decorate my office, and buy a nice jet and give myself bonuses in actual cash. With the rest of the excess profits, maybe I'll grow the company, and you can sell your shares for a higher price to some other guy, who also will never get a cent from me, but will be willing to pay you handsomely for the shares hoping that he can sell it to another guy 3 years from now for even more money!"

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Re: Help me understand dividends

Post by GuitarXM » Wed Nov 02, 2016 1:48 am

The point is that GuitarXM is claiming that the policy of dividends is partly what drives stock prices up. Suppose a fund pays a 2% dividend. I was arguing that if this fund didn't pay the 2% dividend, than their capital growth would just increase by exactly 2% (because then the dividend price cut wouldn't have happened), so there would be no effect on return. GuitarXM is arguing (I believe) that this is wrong: issuing dividends causes capital growth to be larger than it otherwise would be; the 2% wouldn't exactly cancel out.
Stock prices go up or down for many many reasons.
But for a second, lets assume that there is no speculation. Assume that only dividends affect the stock price.

It's not that stock prices go up just because of dividend payments.
What happens is that before the dividend is given, stock price goes up by that anticipated dividend amount.
People know that they are about to receive free money so they bid the price up leading up to the ex-dividend date
On the ex-dividend date, the stock exchange reduces the price of the stock by adjusting the previous days closing price by the amount of the dividend because the dividend does not belong to the company anymore. It now belongs to the shareholders.

They can chose to reinvest the dividend and by shares at a reduced price. They will still have the same amount of money except now they own more shares which will increase in price as the next dividend approaches.

In reality though the value of the stock is affected by people's opinions of its true value. So if some new information is released that surprises the market whether good or bad will affect the stock price much more than that tiny dividend change. The dividend might not even reduce the price at all. It all depends on the markets opinion of the stock. But in general that is what happens if you take value out of the equation.

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Re: Help me understand dividends

Post by saltycaper » Wed Nov 02, 2016 2:22 am

rbaldini wrote:
Enlighten me. Really.

Every time I get a dividend, the effect on my net worth is 0. Drawing on my knowledge of arithmetic, I conclude that the sum effect of all dividends over time is 0. I really, truly don't get it.
You get it just fine. A dividend in itself means nothing except taxes.

---

I'm quoting Alex here mostly because he raises a number of points that often get mixed up in the dividend discussion, not to single him out.
alex_686 wrote:
So I will ask you again, if not dividends how do you plan to get your cash? What makes stocks different from tulip bulbs or Beanie Babies? Won't these always trade higher?
The difference is that companies generate earnings, while tulip bulbs and Beanie Babies do not. Investors placing value on earnings seems to endure, even though the amount investors are willing to pay for a dollar of earnings varies. Of course, besides dividends, you may receive cash by selling shares you own, by the company buying back shares (either shares you own, or more likely, shares someone else owns, making your shares worth more, which you can then sell), or by the company being bought by another company in a cash or partial cash deal. I know you already know these things--just reiterating them.
alex_686 wrote:
Maybe your answer is stock buy backs. If so that just may be a debate on semantics. Same function, different form.
If only semantics was at the heart of the matter. Unfortunately, some posters still seem to argue without evidence that receiving a dividend is somehow beneficial in itself, even preferable. This idea needs to be dispatched--with extreme prejudice--before moving on to the merits of returning cash to shareholders.
alex_686 wrote:
Maybe you answer is that you will sell you stock. If so let me inform you of the many practical ways that might not work. I will point to my book recommendation, "Barbarians at the Gate: The Fall of RJR Nabisco". You stock may have a book value of $100 but it is only selling for $70. Instead of paying dividend RJR invested in failing projects, corporate empire building, and flying the CEO's dog around in a private jet. The company was actively destroying shareholder value. If you were in that situation what are your options?

There are many ways that managers can abuse shareholders. Paying dividends is one way of limiting that abuse.
Again, it's a question of returning cash/value to shareholders, and that doesn't have to mean paying dividends, as you note ("one way").
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Re: Help me understand dividends

Post by saltycaper » Wed Nov 02, 2016 2:38 am

HomerJ wrote:
Stocks can go up AND down... Dividends can also be cut, but it's more rare. A 2% dividend means you're going to get that 2% return on your investment even if the stock drops a bit. (if the stocks drop a LOT, the dividend may also be cut, so nothing Is certain).
The only way this matters is if you look at your 2% dividend but ignore what's happened to the price, which has either fallen more or increased less due to the payment of the dividend.
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Re: Help me understand dividends

Post by oldcomputerguy » Wed Nov 02, 2016 5:07 am

Here's my perspective.

We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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Re: Help me understand dividends

Post by qwertyjazz » Wed Nov 02, 2016 7:19 am

I think there are two issues being conflated here. The need for dividends to exist in order for a market to exist and the desire to avoid receiving them due to the tax code.
Imagine a company that instead of giving you dividends just happens to invest the profitsin your perfect AA with your preferred instruments too. It would then be valued at a rate you would like and you know it is relatively real so that you do not worry about it when you eventually want to sell. Someone could liquidate it for exactly what you want minus management costs.
Then you can sell shares when you want for personal liquidity and personal tax issues.
That would clearly be preferred to getting dividends at inopportune times.
The problem back to the OP is that this is not the structure. Dividends also act as signals. They are needed to actually have a market.
So as an individual investor you take the negatives of them being paid out in mass in a manner not optimized for the individual but rather the system.
If the individuals are simmilar enough then a Schilling diagram might apply. But everyone has different needs in regards to cash and taxes. So cash is king and the hope of future dividends.
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Re: Help me understand dividends

Post by bamn » Wed Nov 02, 2016 8:15 am

Yeah I think what's been missed is that the reason the fund's value has increased is because it's due to pay a dividend. If it didn't pay dividends, its NAV wouldn't have increased. So yeah, it sucks that when it pays out, it's taxable income; but if it didn't pay out, its NAV wouldn't have increased in the first place (ie. it'd be representative only of the prices of the securities it held)

And even more fundamentally, stock values wouldn't appreciate, if it was a certainty they'd never pay out. Nobody'd speculate on them, (since why would you expect its value to ever appreciate?) and thus the prices would stay at zero. So, perhaps it's not so much that dividends are good things to the investor, but more that they're the necessary evil* that makes it all possible. (*It's really the taxes that are the problem; and just as certain as death.)

I've heard the recommendation that those not wanting dividends might just want to seek a growth-style porfolio, where the chosen stocks are of growing companies who are largely re-investing their profits. There are certainly many funds with this objective. I'm not sure how well that concept aligns with Boglehead philosophy though.

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Re: Help me understand dividends

Post by rbaldini » Wed Nov 02, 2016 8:40 am

alex_686 wrote:Rbaldini, Are we talking about funds or are we talking about stocks?
Good question. I didn't know that this mattered. I invest in (Vanguard) funds; I have never purchased individual stock. So, funds.
alex_686 wrote: So I will ask you again, if not dividends how do you plan to get your cash?
If it's a bond, I can get my cash at any time by selling shares. I log into Vanguard and click sell. My bank is credited within a day or two. I don't need the fund to do this for me on some schedule.

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Re: Help me understand dividends

Post by rbaldini » Wed Nov 02, 2016 8:43 am

HomerJ wrote:A 2% dividend means you're going to get that 2% return on your investment even if the stock drops a bit.
Again, I fail to see this. Maybe this is the difference between stock and stock fund that was suggested to above. But consider this scenario: I buy shares in stock fund. The price stays exactly the same every day, except after dividend payments, after which the price of shares drops exactly equal to the dividend payment as usual. I reinvest dividends. So how much money do I make with this fund? $0. In fact I lose to taxes. Dividends give me nothing.

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Re: Help me understand dividends

Post by rbaldini » Wed Nov 02, 2016 8:47 am

smartinwate wrote: We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.
Well, I think this is wrong. The payment of a dividend gives me nothing, so it couldn't possibly be true. Compounding comes from the fact that price increases between dividends. If it didn't, then you'd get nothing, even if you reinvested dividends.

Now, GuitarXM says that the payment of dividends is partly what causes the price to rise. Maybe he's right, but I can find stock funds that pay very little dividend and still have large price increases (e.g. https://personal.vanguard.com/us/funds/ ... 023#tab=1a). So I'm not fully convinced.

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Re: Help me understand dividends

Post by qwertyjazz » Wed Nov 02, 2016 9:06 am

rbaldini wrote:
smartinwate wrote: We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.
Well, I think this is wrong. The payment of a dividend gives me nothing, so it couldn't possibly be true. Compounding comes from the fact that price increases between dividends. If it didn't, then you'd get nothing, even if you reinvested dividends.

Now, GuitarXM says that the payment of dividends is partly what causes the price to rise. Maybe he's right, but I can find stock funds that pay very little dividend and still have large price increases (e.g. https://personal.vanguard.com/us/funds/ ... 023#tab=1a). So I'm not fully convinced.
If you have a comparison of FUTURE dividends 5, 10, 20 hundred years from now comparison that is better than the current stock or at least adds some information, I would happily give you every cent I will ever have to invest.

What you have - I think - are stock prices which are expectations of future and dividends paid.
A light form of the EMH implies that the actual paying should be in the price of the stock and therefore not impact its own future growth.

Easier to explain with time lines and images than words.
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Re: Help me understand dividends

Post by sixtyforty » Wed Nov 02, 2016 9:32 am

I always thought dividends were more for producing an "income stream" not building wealth. I agree with the earlier posts, that I'm not sure it builds a lot of wealth if you are paying taxes every 3 months, even though most of us are re-investing dividends in growth accounts. However, what about using dividends to produce an income stream for cash that you use ? Let's assume I have a $50,000 dividend portfolio invested in stock funds worth 2,000 shares. On average I get paid .20 cents/share every 3 months. Let's further assume the market takes a hit and my stock portfolio goes from 50K to 25K. I still own 2,000 shares and i will still get the dividend every 3 months (it may drop a bit). If the price does drop, the yield actually goes up, which further attracts more buyers. In essence helping to create a floor if you will. Now, let's assume instead of a dividend paying portfolio of 50K it's purely cap appreciation. In other words, the yield is basically 0. I own 2,000 shares. The portfolio goes from 50K to 25K. I still own the 2,000 shares but now I'm having to sell a portion of my reduced portfolio of $25K every 3 months, which is psychologically very difficult and because there is no yield there may be less buyers coming into to establish any type of floor.

I could be wrong but I see dividends more of an income producing tool rather than a wealth building tool.
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Re: Help me understand dividends

Post by HomerJ » Wed Nov 02, 2016 9:40 am

rbaldini wrote:
HomerJ wrote:A 2% dividend means you're going to get that 2% return on your investment even if the stock drops a bit.
Again, I fail to see this. Maybe this is the difference between stock and stock fund that was suggested to above. But consider this scenario: I buy shares in stock fund. The price stays exactly the same every day, except after dividend payments, after which the price of shares drops exactly equal to the dividend payment as usual. I reinvest dividends. So how much money do I make with this fund? $0. In fact I lose to taxes. Dividends give me nothing.
If a stock pays out a dividend, and then 20 days later, the market crashes 50%, hey, at least you got that dividend.

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Re: Help me understand dividends

Post by rbaldini » Wed Nov 02, 2016 9:40 am

sixtyforty wrote:I always thought dividends were more for producing an "income stream" not building wealth. I agree with the earlier posts, that I'm not sure it builds a lot of wealth if you are paying taxes every 3 months, even though most of us are re-investing dividends in growth accounts. However, what about using dividends to produce an income stream for cash that you use ? Let's assume I have a $50,000 dividend portfolio invested in stock funds worth 2,000 shares. On average I get paid .20 cents/share every 3 months. Let's further assume the market takes a hit and my stock portfolio goes from 50K to 25K. I still own 2,000 shares and i will still get the dividend every 3 months (it may drop a bit). If the price does drop, the yield actually goes up, which further attracts more buyers. In essence helping to create a floor if you will. Now, let's assume instead of a dividend paying portfolio of 50K it's purely cap appreciation. In other words, the yield is basically 0. I own 2,000 shares. The portfolio goes from 50K to 25K. I still own the 2,000 shares but now I'm having to sell a portion of my reduced portfolio of $25K every 3 months, which is psychologically very difficult and because there is no yield there may be less buyers coming into to establish any type of floor.

I could be wrong but I see dividends more of an income producing tool rather than a wealth building tool.
I could also be wrong, but I believe the "income" is imaginary. Yes, the fund is "giving" you $5000 - but the value of your holdings has also dropped by that amount. You have gained nothing in wealth. It's as if your employer provides you income by taking money out of your bank and giving it to you as a check.

Now, if I need $5000 in cash every 3 months for my living expenses, I'll just sell that amount whenever I need it. Then I get exactly the amount I want, rather than some arbitrary dividend amount. Better yet, I can do this at whatever interval I want, and pull out extra whenever necessary. It is not hard to produce this cash stream by myself with very little effort.

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Re: Help me understand dividends

Post by dbr » Wed Nov 02, 2016 9:44 am

HomerJ wrote:
rbaldini wrote:
HomerJ wrote:A 2% dividend means you're going to get that 2% return on your investment even if the stock drops a bit.
Again, I fail to see this. Maybe this is the difference between stock and stock fund that was suggested to above. But consider this scenario: I buy shares in stock fund. The price stays exactly the same every day, except after dividend payments, after which the price of shares drops exactly equal to the dividend payment as usual. I reinvest dividends. So how much money do I make with this fund? $0. In fact I lose to taxes. Dividends give me nothing.
If a stock pays out a dividend, and then 20 days later, the market crashes 50%, hey, at least you got that dividend.
If you sell your holding in the stock and then 20 days later the market crashes 50% you get all of your original holding. Better yet, if you don't invest in the stock at all and later it crashes you still have all your money.

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Re: Help me understand dividends

Post by rbaldini » Wed Nov 02, 2016 9:44 am

HomerJ wrote:
rbaldini wrote:
HomerJ wrote:A 2% dividend means you're going to get that 2% return on your investment even if the stock drops a bit.
Again, I fail to see this. Maybe this is the difference between stock and stock fund that was suggested to above. But consider this scenario: I buy shares in stock fund. The price stays exactly the same every day, except after dividend payments, after which the price of shares drops exactly equal to the dividend payment as usual. I reinvest dividends. So how much money do I make with this fund? $0. In fact I lose to taxes. Dividends give me nothing.
If a stock pays out a dividend, and then 20 days later, the market crashes 50%, hey, at least you got that dividend.
You didn't "get" anything. When fund gave you $100, the value of your holdings dropped $100. If you reinvested the dividend, then you had the same amount invested afterward as before, which means you lost exactly the same amount during the crash as you would have lost without the dividend - except now you have to pay tax on the dividend, instead of writing it all off as a capital loss. Of course, if you didn't reinvest the dividend, then yes, you're better off - but then your point just boils down to just saying "it's better to remove money from a fund prior to a crash", which isn't particularly enlightening.

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Re: Help me understand dividends

Post by Da5id » Wed Nov 02, 2016 9:47 am

rbaldini wrote:
smartinwate wrote: We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.
Well, I think this is wrong. The payment of a dividend gives me nothing, so it couldn't possibly be true. Compounding comes from the fact that price increases between dividends. If it didn't, then you'd get nothing, even if you reinvested dividends.

Now, GuitarXM says that the payment of dividends is partly what causes the price to rise. Maybe he's right, but I can find stock funds that pay very little dividend and still have large price increases (e.g. https://personal.vanguard.com/us/funds/ ... 023#tab=1a). So I'm not fully convinced.
I think when you are buying a stock you are buying a share of the companies assets and its prospective earnings/profits. Whether those earnings are or should be paid out to shareholders (as dividends or stock buybacks) or are retained by the company for investments that will increase future earnings/profits is of course an open question. If a company can't generate a good return by investing the earnings, it should return them to its owners/investors by dividends/buybacks... Whether dividends or buybacks are better choices by a company wishing to return profits to its owners is a source of many unresolved threads in bogleheads, and seems to be a very emotional topic for some.

As a mutual fund investor, I'm personally only interested in total returns. YMMV.

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HomerJ
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Joined: Fri Jun 06, 2008 12:50 pm

Re: Help me understand dividends

Post by HomerJ » Wed Nov 02, 2016 9:56 am

I like dividends because I feel they keep companies somewhat honest.

You can fake the books, but it's harder (not impossible) to fake cash flow, especially over years and years.

Dividends make total sense to me... I own 0.0001% of the company, I get 0.0001% of the profits.
Last edited by HomerJ on Wed Nov 02, 2016 10:11 am, edited 1 time in total.

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HomerJ
Posts: 11920
Joined: Fri Jun 06, 2008 12:50 pm

Re: Help me understand dividends

Post by HomerJ » Wed Nov 02, 2016 10:01 am

dbr wrote:
HomerJ wrote:
rbaldini wrote:
HomerJ wrote:A 2% dividend means you're going to get that 2% return on your investment even if the stock drops a bit.
Again, I fail to see this. Maybe this is the difference between stock and stock fund that was suggested to above. But consider this scenario: I buy shares in stock fund. The price stays exactly the same every day, except after dividend payments, after which the price of shares drops exactly equal to the dividend payment as usual. I reinvest dividends. So how much money do I make with this fund? $0. In fact I lose to taxes. Dividends give me nothing.
If a stock pays out a dividend, and then 20 days later, the market crashes 50%, hey, at least you got that dividend.
If you sell your holding in the stock and then 20 days later the market crashes 50% you get all of your original holding. Better yet, if you don't invest in the stock at all and later it crashes you still have all your money.
The OP asked why the dividend is considered a "certain" return. Stock prices move up and down. You have no idea what the stock price will be in a year, but one component is much more "certain". If nothing else, you'll make 2% off that stock this year. (Yes, dividends can be cut... so nothing is 100% "certain")

And no I don't automatically re-invest dividends. I send them to a MM account, and then use them to rebalance at the end of the year. And when I retire, I'll use them as income.

GuitarXM
Posts: 421
Joined: Sat Jun 18, 2016 12:09 am

Re: Help me understand dividends

Post by GuitarXM » Wed Nov 02, 2016 10:02 am

rbaldini wrote:
smartinwate wrote: We've all heard time and time again about the "magic" of compounding that comes from re-investing dividends. Without dividends, the only gain from stocks is capital appreciation in share price. So the only way to re-invest would be to sell shares first, which makes no sense whatsoever.
Well, I think this is wrong. The payment of a dividend gives me nothing, so it couldn't possibly be true. Compounding comes from the fact that price increases between dividends. If it didn't, then you'd get nothing, even if you reinvested dividends.

Now, GuitarXM says that the payment of dividends is partly what causes the price to rise. Maybe he's right, but I can find stock funds that pay very little dividend and still have large price increases (e.g. https://personal.vanguard.com/us/funds/ ... 023#tab=1a). So I'm not fully convinced.
First of all you don't know if that price increases because dividends were withheld.
It could be that those stocks got more valuable to do new information about those stocks and people are willing to pay more money for them. You have to remember that when you take speculation out and look at the long term picture prices follow earnings. If its a new company, it has room to grow so they tend to pay 0 dividend to you. They reinvest the dividend to raise future earnings. More often than not, this strategy fails, and the company wastes money that in reality belong to you as a dividend. That's what I said earlier, when the company is too big to increase earnings, you are better off getting a dividend or have the company buy back its shares which will reduce the share amount increasing earnings per share and therefore driving the price up.

Price changes for various reasons but the market is mostly efficient. People aren't that stupid. They know that a dividend is about to be paid out so they increase the price of the stock by the dividend amount. So you didn't lose anything. You got a dividend and the stock price ultimately remained the same. The value of the company drops by the dividend amount cause the company lost that money and gave it to the shareholders. The shareholders expect the dividend in the future so the stock price rises to what it was before. This is a simplified version that doesn't take account of value of the company which is what really drives the price.

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