Dividends are not coupons(interest)

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MIretired
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Dividends are not coupons(interest)

Post by MIretired » Mon Jul 02, 2018 1:53 pm

I responded to another thread with this. And it being not on the OP topic, exactly, thought I'd reprint my comments again:
MIretired wrote: ↑
Mon Jul 02, 2018 1:18 pm

...that the capital structure, so to speak, is completely different for bonds and coupons than for stock ownership and dividends.
eg: A bond coupon is under a contract to pay that coupon; else in default.
With stocks, you are a company owner. A dividend payment is a drawdown(term used in bookkeeping), or cash distribution of part of the assets which you are an owner of, again.
In a company financial statement and income statement done quarterly, the net (reported) earnings move over to the balance sheet (assets - liabilities). The dividend is then withdrawn from the assets(balance sheet.) This is not contractual. It is just a disbursement(drawdown) of company assets to you, an owner of the company.
I didn't find a wiki reference to company bookkeeping in a search.

And, as the time for a dividend payment approaches, there is no appreciation built into the stock price for the coming divdend. It is simply a one time withdrawal of capital to whomever owns the stock at the date. The dividend is not a gain at all. It is a transfer of cash to the owners of the company.

...

To me it could be kind of on topic. As where the dividends lie is somewhat relevant.
But, I wouldn't say there is cash building in the coffers as dividends, but as just earnings. Earnings are accruing, and rate how the company is doing (at least as a quarterly measurement, unless there are anouncements, etc.)
Dividend payments are NOT accruing. They are a block transfer of assets(cash/drawdown) back to the owners. 2nd thought: maybe "drawdown" isn't the best description, as it is used in sole proprietorships and bank transfers. But it's a cash-out of the company to the owners.
Also, 2nd thought: there are no earnings (accruing or otherwise) until the reporting happens. But there is an accruing (usually) cashflow. It's not called earnings until the reporting to IRS is done.
Edit: or it's the SEC that's reported to? lol
Do people think this is a helpful way to explain dividend payments?
Any insufficiency or flaws in it?
Any thoughts welcome.

dbr
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Re: Dividends are not coupons(interest)

Post by dbr » Mon Jul 02, 2018 2:03 pm

I think I agree with the point of your discussion. It probably needs to be shorter. The essence of the comment is that dividends are a payment out of the assets of the company. At the time the payment is made the assets will become less by that amount, all other transactions accounted for. Between dividend payments the assets of the company constantly increase and decrease due to operations (earnings) and there is no particular asset that comprises accruing dividends (though the company may set aside a cash reserve to make the dividend payment).

The data is that for most stocks paying dividends the standard deviation of daily returns is of similar magnitude as the quarterly yield. This means it would be hard to actually see dividends taken into account in the price due to noise. I once read that the opening "bid" on stock exchanges is in fact adjusted after a dividend payable date is reached so that the market opens appropriately. I am not sure I understand that process. I once read a paper that tried to extract stock price changes at dividend payment and that concluded that on average share price drops by the after tax value of the dividend payout, averaged over the estimated tax burden of all stockholders.

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Re: Dividends are not coupons(interest)

Post by bgf » Mon Jul 02, 2018 2:10 pm

OP has it right by distinguishing between being part owner (equity/shares) or creditor (bondholder). dividends go to owners, coupon payments go to creditors. two very different things.

i think it might be simplest to just break down all the ways management at a company can utilize the money it generates through its operations.

1) reinvest in operations
2) acquire new assets
3) buy back its shares
4) pay out dividends

a company can do the above either with money it generated on its own or buy borrowing.

the decision the management makes can be good for shareholders (create value) or bad for shareholders (destroy value). none of the these options is in itself good or bad. it has to be judged based on context, and many times you will never know whether the decision was a good or bad one until well into the future. even paying dividends could be a destructive use of capital if the company could have reinvested that money at a higher return to grow the business.

at the end of the day, you need to trust management to make good decisions, on the whole, as to how the company's capital is allocated. how well the company does this will play a large role in how well your investment turns out years down the road.

when it comes to bonds, it is a much different story. all you care about is that the company does not default on its bonds. so long as it stays afloat, you get your coupon payments and whether the company later runs itself into the ground, it doesn't really matter to you.
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Re: Dividends are not coupons(interest)

Post by invstar » Mon Jul 02, 2018 2:22 pm

Why do they call bond fund monthly/quarterly payments as dividends? Are they not coupons/interest payments?

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Re: Dividends are not coupons(interest)

Post by MIretired » Mon Jul 02, 2018 2:23 pm

dbr wrote:
Mon Jul 02, 2018 2:03 pm
I think I agree with the point of your discussion. It probably needs to be shorter. 1.The essence of the comment is that dividends are a payment out of the assets of the company. At the time the payment is made the assets will become less by that amount, all other transactions accounted for. Between dividend payments the assets of the company constantly increase and decrease due to operations (earnings) and there is no particular asset that comprises accruing dividends (though the company may set aside a cash reserve to make the dividend payment).

2.The data is that for most stocks paying dividends the standard deviation of daily returns is of similar magnitude as the quarterly yield. This means it would be hard to actually see dividends taken into account in the price due to noise. I once read that the opening "bid" on stock exchanges is in fact adjusted after a dividend payable date is reached so that the market opens appropriately. I am not sure I understand that process. I once read a paper that tried to extract stock price changes at dividend payment and that concluded that on average share price drops by the after tax value of the dividend payout, averaged over the estimated tax burden of all stockholders.
I just did a complete rambling quote of myself because of the ease. It could be whittled down.
1. I basically just call it assets and income. I did recently got it drilled into my mind that the reported earnings(income) move to the assets once locked in at tax reporting time. I'm calling it cashflow until this occurs.
2. I thought, from M*, that monthly standard deviation(SD) can be transformed into yearly SD by taking the 12th root of monthly. And thus I'd assume the same when changing daily SD to quarterly SD?? Something on my to learn list. As far as payout time noise-- don't know that one. Takes some thought. What with 24/7 markets? When are they marked to market? lol After tax? lol

MIretired
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Re: Dividends are not coupons(interest)

Post by MIretired » Mon Jul 02, 2018 2:28 pm

bgf wrote:
Mon Jul 02, 2018 2:10 pm
OP has it right by distinguishing between being part owner (equity/shares) or creditor (bondholder). dividends go to owners, coupon payments go to creditors. two very different things.

i think it might be simplest to just break down all the ways management at a company can utilize the money it generates through its operations.

1) reinvest in operations
2) acquire new assets
3) buy back its shares
4) pay out dividends

a company can do the above either with money it generated on its own or buy borrowing.

the decision the management makes can be good for shareholders (create value) or bad for shareholders (destroy value). none of the these options is in itself good or bad. it has to be judged based on context, and many times you will never know whether the decision was a good or bad one until well into the future. even paying dividends could be a destructive use of capital if the company could have reinvested that money at a higher return to grow the business.

at the end of the day, you need to trust management to make good decisions, on the whole, as to how the company's capital is allocated. how well the company does this will play a large role in how well your investment turns out years down the road.

when it comes to bonds, it is a much different story. all you care about is that the company does not default on its bonds. so long as it stays afloat, you get your coupon payments and whether the company later runs itself into the ground, it doesn't really matter to you.
Right. Some of this stuff has gone through my head. But there's so many spin offs. Also, what about expected earnings estimates and earnings growth rates expected. And the dividend discount model. All of these to come up with a current price/share of the company. Sounds like a book or course.
Think a lot about company use of cash.

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Re: Dividends are not coupons(interest)

Post by simplesimon » Mon Jul 02, 2018 2:30 pm

invstar wrote:
Mon Jul 02, 2018 2:22 pm
Why do they call bond fund monthly/quarterly payments as dividends? Are they not coupons/interest payments?
I don't know the exact answer, but I imagine it's because it is a fund (a basket of assets, or bonds) rather than a bond between the investor and the borrower.

MIretired
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Re: Dividends are not coupons(interest)

Post by MIretired » Mon Jul 02, 2018 2:31 pm

invstar wrote:
Mon Jul 02, 2018 2:22 pm
Why do they call bond fund monthly/quarterly payments as dividends? Are they not coupons/interest payments?
Don't know. Maybe it's called a coupon when it's an individual bond. And a dividend when it's a fund of bonds, and the fund received the individual coupons throughtout the month/quarter. This description makes sense to me. Don't know by an expert.

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Phineas J. Whoopee
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Re: Dividends are not coupons(interest)

Post by Phineas J. Whoopee » Mon Jul 02, 2018 2:35 pm

invstar wrote:
Mon Jul 02, 2018 2:22 pm
Why do they call bond fund monthly/quarterly payments as dividends? Are they not coupons/interest payments?
In the US, at least, mutual funds are organized under corporate law. Being corporations their distributions to shareholders are dividends, although the money comes from underlying bond coupons.

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Re: Dividends are not coupons(interest)

Post by Leesbro63 » Mon Jul 02, 2018 2:38 pm

I think the issue became an issue due to the rise in popularity of bond mutual funds over the last generation. Until not too many years ago (less than 10), bond fund payments were known as "interest" and reported as "interest" on Federal tax returns. Somewhere about 2012, this changed and bond fund "interest" started having to be reported as "dividends". Technically they are that..bond fund dividends, which represent the pass-through of interest. They generally are not "qualified" dividends. Qualified dividends are generally stock dividends from publicly traded companies who already had income subject to the corporate income tax. There are also "tax-free dividends" which are a pass-through of tax exempt municipal bond interest.

I agree this has all become confusing. I prefer to think of "dividends and interest" in the traditional sense of dividends coming from stock investments and interest coming from bond investments. Even though, now, some interest is actually paid out to the investor as an "interest dividend" via a bond mutual fund.

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Phineas J. Whoopee
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Re: Dividends are not coupons(interest)

Post by Phineas J. Whoopee » Mon Jul 02, 2018 2:41 pm

dbr wrote:
Mon Jul 02, 2018 2:03 pm
... I once read that the opening "bid" on stock exchanges is in fact adjusted after a dividend payable date is reached so that the market opens appropriately. I am not sure I understand that process. ...
Should investors leave limit orders open overnight the exchange adjusts them by the amount of the dividend. It keeps those not in the know from being fleeced by those who understand what dividends are and how they work.

None of that stops investors, both individuals and institutions, from placing new limit orders for the opening bell. The exchange does not control the order book. It just manages it.

The market opens wherever it opens, with bids and asks matched. The adjusted limit orders may never be filled, just like any other limit order.

Does that make sense?

PJW

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Re: Dividends are not coupons(interest)

Post by dbr » Mon Jul 02, 2018 2:42 pm

The real confusion, though, is when people think of stock dividends being like interest. I think that is one of the starting points for confusion about "dividend investing" and about principal and income.

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Re: Dividends are not coupons(interest)

Post by dbr » Mon Jul 02, 2018 2:42 pm

Phineas J. Whoopee wrote:
Mon Jul 02, 2018 2:41 pm
dbr wrote:
Mon Jul 02, 2018 2:03 pm
... I once read that the opening "bid" on stock exchanges is in fact adjusted after a dividend payable date is reached so that the market opens appropriately. I am not sure I understand that process. ...
Should investors leave limit orders open overnight the exchange adjusts them by the amount of the dividend. It keeps those not in the know from being fleeced by those who understand what dividends are and how they work.

None of that stops investors, both individuals and institutions, from placing new limit orders for the opening bell. The exchange does not control the order book. It just manages it.

The market opens wherever it opens, with bids and asks matched. The adjusted limit orders may never be filled, just like any other limit order.

Does that make sense?

PJW
Thanks. I was trying to remember what I read about that.

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Phineas J. Whoopee
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Re: Dividends are not coupons(interest)

Post by Phineas J. Whoopee » Mon Jul 02, 2018 2:52 pm

MIretired wrote:
Mon Jul 02, 2018 1:53 pm
...
Do people think this is a helpful way to explain dividend payments?
Any insufficiency or flaws in it?
Any thoughts welcome.
I agree it's too long and complex. People who can comprehend it on a first reading already understand the difference between dividends and interest.

How to explain that well has been an ongoing struggle. It is absolutely clear that many individuals, including some posters here, mistake dividends for interest, and stock for a savings account. That's why we so often see references to not losing "principal" in stocks or a stock fund, and why some posters show so much resistance to the fact that dividends are simply a forced sale of the corporation's or the fund's underlying assets.

I agree, though, that we should give it another try.

PJW

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Re: Dividends are not coupons(interest)

Post by JoMoney » Mon Jul 02, 2018 2:58 pm

Just to confuse things, or maybe it will highlight the indifference of what the transfer is really doing, I'll throw in that there's a distinction between a "cash dividend" and a "stock dividend".
There were a lot of stock dividends issued by REITs during the financial crisis.
In some situations, issuing a stock dividend is ideal. It doesn't force a taxable event on the owner, who might otherwise just reinvest the dividend back into buying more shares, but if the investor chooses to take the cash and taxable event they can sell the shares. On the company side, presuming they have a need to keep and use the cash, and would otherwise have to borrow / issue bonds, if they instead issue equity shares this may provide them an easier to access credit facility (especially if they think their stock is over-valued relative to their credit worthiness on the credit markets).
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Re: Dividends are not coupons(interest)

Post by MIretired » Mon Jul 02, 2018 3:01 pm

dbr wrote:
Mon Jul 02, 2018 2:42 pm
Phineas J. Whoopee wrote:
Mon Jul 02, 2018 2:41 pm
dbr wrote:
Mon Jul 02, 2018 2:03 pm
... I once read that the opening "bid" on stock exchanges is in fact adjusted after a dividend payable date is reached so that the market opens appropriately. I am not sure I understand that process. ...
Should investors leave limit orders open overnight the exchange adjusts them by the amount of the dividend. It keeps those not in the know from being fleeced by those who understand what dividends are and how they work.

None of that stops investors, both individuals and institutions, from placing new limit orders for the opening bell. The exchange does not control the order book. It just manages it.

The market opens wherever it opens, with bids and asks matched. The adjusted limit orders may never be filled, just like any other limit order.

Does that make sense?

PJW
Thanks. I was trying to remember what I read about that.
Yeh. Bids and asks; not about a concept of marked to market. It's always a bid and ask system? So for a specific stock, everything trades on one exchange; or all exchanges are synced?; and all at 4PM EST? That right? I think that is what you're implying.
Think this has been gone through many times, but I wasn't as interested at the time. As long as they manage it fairly.

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Re: Dividends are not coupons(interest)

Post by Phineas J. Whoopee » Mon Jul 02, 2018 3:19 pm

MIretired wrote:
Mon Jul 02, 2018 3:01 pm
...
Yeh. Bids and asks; not about a concept of marked to market. It's always a bid and ask system? So for a specific stock, everything trades on one exchange; or all exchanges are synced?; and all at 4PM EST? That right? I think that is what you're implying.
Think this has been gone through many times, but I wasn't as interested at the time. As long as they manage it fairly.
The middle portion of this post of mine runs through stock market mechanics. It's in a thread about the Efficient Market Hypothesis, but market mechanics are the same with or without it.

PJW

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Re: Dividends are not coupons(interest)

Post by MIretired » Mon Jul 02, 2018 7:22 pm

Phineas J. Whoopee wrote:
Mon Jul 02, 2018 3:19 pm
MIretired wrote:
Mon Jul 02, 2018 3:01 pm
...
Yeh. Bids and asks; not about a concept of marked to market. It's always a bid and ask system? So for a specific stock, everything trades on one exchange; or all exchanges are synced?; and all at 4PM EST? That right? I think that is what you're implying.
Think this has been gone through many times, but I wasn't as interested at the time. As long as they manage it fairly.
The middle portion of this post of mine runs through stock market mechanics. It's in a thread about the Efficient Market Hypothesis, but market mechanics are the same with or without it.

PJW
I pay for level 2. So like you, I am not leched upon.

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Re: Dividends are not coupons(interest)

Post by alex_686 » Mon Jul 02, 2018 10:07 pm

dbr wrote:
Mon Jul 02, 2018 2:03 pm
The data is that for most stocks paying dividends the standard deviation of daily returns is of similar magnitude as the quarterly yield. This means it would be hard to actually see dividends taken into account in the price due to noise.
Maybe. One can easy parse out the affects of the expected accrued dividends. The example I am specifically thinking about is derivative pricing where one needs to calculate the accrued dividend. One can actually see little bumps in option prices over each expected dividend payment and one can actually work backwards to figure out market expectations.

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Re: Dividends are not coupons(interest)

Post by BeBH65 » Tue Jul 03, 2018 1:54 am

invstar wrote:
Mon Jul 02, 2018 2:22 pm
Why do they call bond fund monthly/quarterly payments as dividends? Are they not coupons/interest payments?
It agrees with the definition given above: "Dividends are paid out of the assets"
Which is the case with bond funds.

Edit: spelling
Last edited by BeBH65 on Tue Jul 03, 2018 6:32 am, edited 1 time in total.
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence).

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Re: Dividends are not coupons(interest)

Post by JoMoney » Tue Jul 03, 2018 2:09 am

invstar wrote:
Mon Jul 02, 2018 2:22 pm
Why do they call bond fund monthly/quarterly payments as dividends? Are they not coupons/interest payments?
Because a mutual fund is a company ( a Regulated Investment Company ) that must pass it's income through to the owners (as dividends).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Dividends are not coupons(interest)

Post by nisiprius » Tue Jul 03, 2018 5:54 am

JoMoney wrote:
Tue Jul 03, 2018 2:09 am
invstar wrote:
Mon Jul 02, 2018 2:22 pm
Why do they call bond fund monthly/quarterly payments as dividends? Are they not coupons/interest payments?
Because a mutual fund is a company ( a Regulated Investment Company ) that must pass it's income through to the owners (as dividends).
And incidentally, although we take it for granted, it was a very big deal that the Investment Company Act of 1940 provided that an investment company (unlike other corporations) does not have to pay corporate income tax on that income.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Dividends are not coupons(interest)

Post by nisiprius » Tue Jul 03, 2018 6:06 am

I agree that MIRetired's post is too advanced. I think the confusion comes at a much simpler level (and is often the result of intentional obfuscation by people whose self-interest is served by selling something other than bonds).

People believe, correctly, that in a fundamental sense bonds are less risky than stocks, because they are a promise--actually, a legal contract enforceable in court--by the issuer, to pay specific numbers of dollars on specific days. Furthermore, they are required to pay all their bills first--including bond interest--before they can look at what they might be able to pay out to shareholders.

People selling, or enthusiastic about other asset classes like to shift the ground on "why bonds" by suggesting that the fundamental thing about bonds isn't debt-versus-equity, guaranteed-versus-not-guaranteed, it's that bonds "provide an income stream." They then argue that you can think of anything that provides an income stream as being "like a bond." No.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Dividends are not coupons(interest)

Post by dbr » Tue Jul 03, 2018 9:47 am

nisiprius wrote:
Tue Jul 03, 2018 6:06 am

People selling, or enthusiastic about other asset classes like to shift the ground on "why bonds" by suggesting that the fundamental thing about bonds isn't debt-versus-equity, guaranteed-versus-not-guaranteed, it's that bonds "provide an income stream." They then argue that you can think of anything that provides an income stream as being "like a bond." No.
Certainly on many threads here the essence of the question and problem is someone somehow starting out with the preconceived idea that to get income from a portfolio of investments you can only collect the interest and dividends, whatever difference there may be between them being glossed over. The confusion between "coupon" on a bond and dividends paid by a bond fund is a sidetrack in the same direction. Getting to the point of understanding "withdrawing" from a portfolio is a long, hard slog.

On a different set of threads the idea that an income stream is like a bond leads to many threads that confuse what asset allocation is all about. It doesn't help that Mr. Bogle has even talked about "treating" SS as a bond, but I doubt Mr. Bogle has ever thought SS is a bond. Unforturnately what "treat" or "consider" means is subtle and mysterious.

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Re: Dividends are not coupons(interest)

Post by Pajamas » Tue Jul 03, 2018 10:07 am

Why reinvent the wheel? There are simple and easily understood definitions of dividends and interest out there.

In my mind, the ultimate underlying difference is that one is based on equity or ownership and the other is based on debt or lending.

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Re: Dividends are not coupons(interest)

Post by bhsince87 » Tue Jul 03, 2018 10:41 am

In the past, we could refer to bonds as "fixed income". A deal is agreed to, and the income from the interest was guaranteed (mostly) to be paid according to the agreed upon schedule. If not paid, the bond owner could take legal measures to enforce the contract.

A dividend, on the other hand, was not fixed income. It could vary over time , up or down, with no legal recourse to the recipient if the dividend went to zero. That's the deal you signed up for when you bought the shares.

Bond funds and ETFs make this a bit murkier though. While the underlying bonds are probably still "fixed income", the buying and selling and maturation of the bonds makes the net income to a fund share owner variable.
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Re: Dividends are not coupons(interest)

Post by dbr » Tue Jul 03, 2018 10:48 am

bhsince87 wrote:
Tue Jul 03, 2018 10:41 am
In the past, we could refer to bonds as "fixed income". A deal is agreed to, and the income from the interest was guaranteed (mostly) to be paid according to the agreed upon schedule. If not paid, the bond owner could take legal measures to enforce the contract.

A dividend, on the other hand, was not fixed income. It could vary over time , up or down, with no legal recourse to the recipient if the dividend went to zero. That's the deal you signed up for when you bought the shares.

Bond funds and ETFs make this a bit murkier though. While the underlying bonds are probably still "fixed income", the buying and selling and maturation of the bonds makes the net income to a fund share owner variable.
Of course, actual single bonds mature and are bought and sold. For example the standard deviation of annual returns of even CDs is not zero, because the variation in interest rates when the matured CD is replaced with a new one is not zero.

Perhaps the only real example of fixed income would be consols https://en.wikipedia.org/wiki/Consol_(bond) but even those are not available in real currency (inflation indexed) and can and have been fully redeemed at the option of the issuers.

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Re: Dividends are not coupons(interest)

Post by bhsince87 » Tue Jul 03, 2018 11:19 am

dbr wrote:
Tue Jul 03, 2018 10:48 am
bhsince87 wrote:
Tue Jul 03, 2018 10:41 am
In the past, we could refer to bonds as "fixed income". A deal is agreed to, and the income from the interest was guaranteed (mostly) to be paid according to the agreed upon schedule. If not paid, the bond owner could take legal measures to enforce the contract.

A dividend, on the other hand, was not fixed income. It could vary over time , up or down, with no legal recourse to the recipient if the dividend went to zero. That's the deal you signed up for when you bought the shares.

Bond funds and ETFs make this a bit murkier though. While the underlying bonds are probably still "fixed income", the buying and selling and maturation of the bonds makes the net income to a fund share owner variable.

Of course, actual single bonds mature and are bought and sold. For example the standard deviation of annual returns of even CDs is not zero, because the variation in interest rates when the matured CD is replaced with a new one is not zero.

Perhaps the only real example of fixed income would be consols https://en.wikipedia.org/wiki/Consol_(bond) but even those are not available in real currency (inflation indexed) and can and have been fully redeemed at the option of the issuers.
The income is fixed during the length of the contract (i.e,until the bond matures or CD expires). Unless the bond or CD is callable.
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Re: Dividends are not coupons(interest)

Post by dbr » Tue Jul 03, 2018 11:25 am

bhsince87 wrote:
Tue Jul 03, 2018 11:19 am
dbr wrote:
Tue Jul 03, 2018 10:48 am
bhsince87 wrote:
Tue Jul 03, 2018 10:41 am
In the past, we could refer to bonds as "fixed income". A deal is agreed to, and the income from the interest was guaranteed (mostly) to be paid according to the agreed upon schedule. If not paid, the bond owner could take legal measures to enforce the contract.

A dividend, on the other hand, was not fixed income. It could vary over time , up or down, with no legal recourse to the recipient if the dividend went to zero. That's the deal you signed up for when you bought the shares.

Bond funds and ETFs make this a bit murkier though. While the underlying bonds are probably still "fixed income", the buying and selling and maturation of the bonds makes the net income to a fund share owner variable.

Of course, actual single bonds mature and are bought and sold. For example the standard deviation of annual returns of even CDs is not zero, because the variation in interest rates when the matured CD is replaced with a new one is not zero.

Perhaps the only real example of fixed income would be consols https://en.wikipedia.org/wiki/Consol_(bond) but even those are not available in real currency (inflation indexed) and can and have been fully redeemed at the option of the issuers.
The income is fixed during the length of the contract (i.e,until the bond matures or CD expires). Unless the bond or CD is callable.
The point is that the practical significance of that is over-rated. Even using assets to exchange for lifetime fixed income in the form of an SPIA is still problematic with respect to inflation unless one finds an indexed annuity. Similarly most holders of bonds do not actually use TIPS, which is strange as it is the only fixed income deal, along with I bonds, that actually makes sense as income. An even then the most effective practical use of TIPS is actually a sinking fund that consumes the principal, meaning the LMP concept.

bhsince87
Posts: 1857
Joined: Thu Oct 03, 2013 1:08 pm

Re: Dividends are not coupons(interest)

Post by bhsince87 » Tue Jul 03, 2018 12:06 pm

dbr wrote:
Tue Jul 03, 2018 11:25 am
bhsince87 wrote:
Tue Jul 03, 2018 11:19 am
dbr wrote:
Tue Jul 03, 2018 10:48 am
bhsince87 wrote:
Tue Jul 03, 2018 10:41 am
In the past, we could refer to bonds as "fixed income". A deal is agreed to, and the income from the interest was guaranteed (mostly) to be paid according to the agreed upon schedule. If not paid, the bond owner could take legal measures to enforce the contract.

A dividend, on the other hand, was not fixed income. It could vary over time , up or down, with no legal recourse to the recipient if the dividend went to zero. That's the deal you signed up for when you bought the shares.

Bond funds and ETFs make this a bit murkier though. While the underlying bonds are probably still "fixed income", the buying and selling and maturation of the bonds makes the net income to a fund share owner variable.

Of course, actual single bonds mature and are bought and sold. For example the standard deviation of annual returns of even CDs is not zero, because the variation in interest rates when the matured CD is replaced with a new one is not zero.

Perhaps the only real example of fixed income would be consols https://en.wikipedia.org/wiki/Consol_(bond) but even those are not available in real currency (inflation indexed) and can and have been fully redeemed at the option of the issuers.
The income is fixed during the length of the contract (i.e,until the bond matures or CD expires). Unless the bond or CD is callable.
The point is that the practical significance of that is over-rated. Even using assets to exchange for lifetime fixed income in the form of an SPIA is still problematic with respect to inflation unless one finds an indexed annuity. Similarly most holders of bonds do not actually use TIPS, which is strange as it is the only fixed income deal, along with I bonds, that actually makes sense as income. An even then the most effective practical use of TIPS is actually a sinking fund that consumes the principal, meaning the LMP concept.
So you are saying that maybe dividends and interest are the same thing in that respect?
Retirement: When you reach a point where you have enough. Or when you've had enough.

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willthrill81
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Re: Dividends are not coupons(interest)

Post by willthrill81 » Tue Jul 03, 2018 12:10 pm

Here's a simple illustration of why the OP is correct.

Assume that you own a business. This business has $10,000 in cash, and you transfer this money from the business to your personal checking account. Has your net worth changed? No, the reduction of the business's assets is perfectly offset by the increase in your personal checking account. Nothing has been gained or lost by the transaction.

The same is true of dividends.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

dbr
Posts: 27207
Joined: Sun Mar 04, 2007 9:50 am

Re: Dividends are not coupons(interest)

Post by dbr » Tue Jul 03, 2018 12:17 pm

bhsince87 wrote:
Tue Jul 03, 2018 12:06 pm
dbr wrote:
Tue Jul 03, 2018 11:25 am
bhsince87 wrote:
Tue Jul 03, 2018 11:19 am
dbr wrote:
Tue Jul 03, 2018 10:48 am
bhsince87 wrote:
Tue Jul 03, 2018 10:41 am
In the past, we could refer to bonds as "fixed income". A deal is agreed to, and the income from the interest was guaranteed (mostly) to be paid according to the agreed upon schedule. If not paid, the bond owner could take legal measures to enforce the contract.

A dividend, on the other hand, was not fixed income. It could vary over time , up or down, with no legal recourse to the recipient if the dividend went to zero. That's the deal you signed up for when you bought the shares.

Bond funds and ETFs make this a bit murkier though. While the underlying bonds are probably still "fixed income", the buying and selling and maturation of the bonds makes the net income to a fund share owner variable.

Of course, actual single bonds mature and are bought and sold. For example the standard deviation of annual returns of even CDs is not zero, because the variation in interest rates when the matured CD is replaced with a new one is not zero.

Perhaps the only real example of fixed income would be consols https://en.wikipedia.org/wiki/Consol_(bond) but even those are not available in real currency (inflation indexed) and can and have been fully redeemed at the option of the issuers.
The income is fixed during the length of the contract (i.e,until the bond matures or CD expires). Unless the bond or CD is callable.
The point is that the practical significance of that is over-rated. Even using assets to exchange for lifetime fixed income in the form of an SPIA is still problematic with respect to inflation unless one finds an indexed annuity. Similarly most holders of bonds do not actually use TIPS, which is strange as it is the only fixed income deal, along with I bonds, that actually makes sense as income. An even then the most effective practical use of TIPS is actually a sinking fund that consumes the principal, meaning the LMP concept.
So you are saying that maybe dividends and interest are the same thing in that respect?
My view would be that while the financial characteristics of dividends and interest are quite different (if financial is the right term), the investment aspects of both are indeed that they are the same thing. The reason for that is that the most simple and rational way for an investor to characterize assets is by describing the distribution of annual (or other period) returns, usually be giving a mean, the expected return, and a variation around the mean, usually called the risk. While the measure for the mean is somewhat straightforward, the description of the variation is more nuanced. That is a topic for a different discussion, but the essence of it is what kind of distribution even makes sense to describe the variation.

Anyway, interest and dividends are exactly alike in that they are components of the return. What fraction of the annual return is represented by each varies considerably even within bonds or within stocks, so there is no really useful distinction there. That is why I pointed out that even the return from CDs regarded as an asset class is not free of risk. In case a person is concerned at whether or not this risk is real, consider the wailing and gnashing of teeth we could read here only a year or two ago as people with 5% paying CDs were finding that the most they could get on renewal was 1%. An 80% pay cut is not trivial, that is, if people mistake interest paid for how you get income. In that case the variation was comparable in size to the mean at 4% range on an average of 3%.

alex_686
Posts: 3935
Joined: Mon Feb 09, 2015 2:39 pm

Re: Dividends are not coupons(interest)

Post by alex_686 » Tue Jul 03, 2018 12:42 pm

bhsince87 wrote:
Tue Jul 03, 2018 12:06 pm
So you are saying that maybe dividends and interest are the same thing in that respect?
Let me extend a bit on what dbr is saying.

Dividends and interest do not matter, it is "Total Return" and "Free Cash Flow" that matters. We can use this universal generalized framework to evaluate non-dividend paying stocks, dividend paying stocks, bonds, and real estate. We can even apply this to more esoteric things like home ownership and social security.

We can then descend down into different types of return, the risk involved, and the taxes involved in different types of income. What is the impact of interest payments being converted into dividend payments? Not much from either a economic or tax viewpoint. What is the difference between a bond and a preferred stock? Or do you want to talk about dividends verse stock buy back?

I strongly believe that it is useful to start at this top level so we one can get a clear idea of what is similar and what is different.

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