The "dividend preference anomaly"

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CULater
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The "dividend preference anomaly"

Post by CULater » Fri Apr 05, 2019 6:09 pm

Article describing investor preference for dividend stocks as an "anomaly." This is also Larry Swedroe's view.
A good many retirees seem to be enamored with the "Spend Interest and Dividends Only" strategy for spending down their retirement savings. The foundation of this strategy is a preference for the value of a dollar generated from dividends over the value of a dollar generated from the sale of stock, or capital gains.

This preference has long been recognized but never quite understood.

...dividends fall under the category of mental accounting. ...a "free dividend fallacy", in which investors view dividends as a source of return that is independent of the price of the stock when in reality the price of the stock is immediately reduced by the value of the dividend when it is paid. This fosters the mistaken belief that dividends are the same as bond interest.
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vineviz
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Re: The "dividend preference anomaly"

Post by vineviz » Fri Apr 05, 2019 6:21 pm

CULater wrote:
Fri Apr 05, 2019 6:09 pm
Article describing investor preference for dividend stocks as an "anomaly." This is also Larry Swedroe's view.
A good many retirees seem to be enamored with the "Spend Interest and Dividends Only" strategy for spending down their retirement savings. The foundation of this strategy is a preference for the value of a dollar generated from dividends over the value of a dollar generated from the sale of stock, or capital gains.

This preference has long been recognized but never quite understood.

...dividends fall under the category of mental accounting. ...a "free dividend fallacy", in which investors view dividends as a source of return that is independent of the price of the stock when in reality the price of the stock is immediately reduced by the value of the dividend when it is paid. This fosters the mistaken belief that dividends are the same as bond interest.
http://www.theretirementcafe.com
I've railed against the dividend fallacy often enough myself, but I also hold the belief that when your economic model says that people are consistently acting in an irrational way that the problem is more likely with your model than with the people.

In other words, I suspect it's highly likely that people who exhibit this ""dividend preference anomaly" aren't being irrational but rather that their utility function isn't well described by economists. In this case, for instance, I suspect that some investors are enjoying more utility from minimizing regret than by maximizing financial profit.

They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.

It's not too dissimilar from the discussion we have had about pensions vs annuities: many people like the idea of a annuitized income so long as someone else (e.g. their employer) decides on the parameters. Having to choose an annuity in the open market FEELS to them like a completely different realm, and they become cognizant that they might "choose wrong".
Last edited by vineviz on Fri Apr 05, 2019 6:23 pm, edited 1 time in total.
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Re: The "dividend preference anomaly"

Post by petulant » Fri Apr 05, 2019 6:22 pm

Is there any evidence one could exploit this fallacy by focusing on non-dividend stocks to earn alpha? If not, why not?

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Re: The "dividend preference anomaly"

Post by petulant » Fri Apr 05, 2019 6:25 pm

vineviz wrote:
Fri Apr 05, 2019 6:21 pm
CULater wrote:
Fri Apr 05, 2019 6:09 pm
Article describing investor preference for dividend stocks as an "anomaly." This is also Larry Swedroe's view.
A good many retirees seem to be enamored with the "Spend Interest and Dividends Only" strategy for spending down their retirement savings. The foundation of this strategy is a preference for the value of a dollar generated from dividends over the value of a dollar generated from the sale of stock, or capital gains.

This preference has long been recognized but never quite understood.

...dividends fall under the category of mental accounting. ...a "free dividend fallacy", in which investors view dividends as a source of return that is independent of the price of the stock when in reality the price of the stock is immediately reduced by the value of the dividend when it is paid. This fosters the mistaken belief that dividends are the same as bond interest.
http://www.theretirementcafe.com
I've railed against the dividend fallacy often enough myself, but I also hold the belief that when your economic model says that people are consistently acting in an irrational way that the problem is more likely with your model than with the people.

In other words, I suspect it's highly likely that people who exhibit this ""dividend preference anomaly" aren't being irrational but rather that their utility function isn't well described by economists. In this case, for instance, I suspect that some investors are enjoying more utility from minimizing regret than by maximizing financial profit.

They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.
I think that's an issue with all behavioral economics/finance issues--the behavioral phenomenon might just reflect the economist's misapprehension of the utility function. But then, if all behavior can just be interpreted as reflecting a different utility function, is the rational choice theory underlying economics non-falsifiable and non-scientific?

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Re: The "dividend preference anomaly"

Post by livesoft » Fri Apr 05, 2019 6:26 pm

vineviz wrote:
Fri Apr 05, 2019 6:21 pm
They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.
Also discussed in this thread on the Dividend Puzzle and a behavioral finance take on it:
viewtopic.php?t=233637

The linked article points to ERN's SWR series:
The Yield Illusion: How Can a High-Dividend Portfolio Exacerbate Sequence Risk? (SWR Series Part 29)

I suppose whenever the dividends vs total return thing comes up that I will just cut & paste this post into those threads.
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Phineas J. Whoopee
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Re: The "dividend preference anomaly"

Post by Phineas J. Whoopee » Fri Apr 05, 2019 6:53 pm

If I may, total return does not mean, as claimed in the linked articles, spend the capital gains. Capital gains may be negative over any period of time. How does one negatively spend?

Gains have nothing to do with it. In total return one spends capital, which includes the value of the assets and any cash they throw off, all of which is capital.

I believe it's dangerously misleading to repeat the notion that in a total return strategy one spends "capital gains." One spends capital, and that is it, even if the person confines their spending to the portion of their capital represented by dividends.

PJW

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Re: The "dividend preference anomaly"

Post by JustinR » Fri Apr 05, 2019 6:56 pm

vineviz wrote:
Fri Apr 05, 2019 6:21 pm
CULater wrote:
Fri Apr 05, 2019 6:09 pm
Article describing investor preference for dividend stocks as an "anomaly." This is also Larry Swedroe's view.
A good many retirees seem to be enamored with the "Spend Interest and Dividends Only" strategy for spending down their retirement savings. The foundation of this strategy is a preference for the value of a dollar generated from dividends over the value of a dollar generated from the sale of stock, or capital gains.

This preference has long been recognized but never quite understood.

...dividends fall under the category of mental accounting. ...a "free dividend fallacy", in which investors view dividends as a source of return that is independent of the price of the stock when in reality the price of the stock is immediately reduced by the value of the dividend when it is paid. This fosters the mistaken belief that dividends are the same as bond interest.
http://www.theretirementcafe.com
I've railed against the dividend fallacy often enough myself, but I also hold the belief that when your economic model says that people are consistently acting in an irrational way that the problem is more likely with your model than with the people.

In other words, I suspect it's highly likely that people who exhibit this ""dividend preference anomaly" aren't being irrational but rather that their utility function isn't well described by economists. In this case, for instance, I suspect that some investors are enjoying more utility from minimizing regret than by maximizing financial profit.

They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.

It's not too dissimilar from the discussion we have had about pensions vs annuities: many people like the idea of a annuitized income so long as someone else (e.g. their employer) decides on the parameters. Having to choose an annuity in the open market FEELS to them like a completely different realm, and they become cognizant that they might "choose wrong".
I'd say the much more likely and simpler explanation is ignorance. 99% of investors simply think that dividends are free money or enjoy receiving money thinking they're richer.

Same exact thing with tax refunds. Most people love receiving it and complain when they don't because they're receiving money versus not receiving money.

Same exact thing. Receive money = feel good.

I doubt even 1% of investors are comparing dividends to selling shares themselves. Or even know that the price went down when they got it.
Last edited by JustinR on Fri Apr 05, 2019 8:48 pm, edited 2 times in total.

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Re: The "dividend preference anomaly"

Post by Dialectical Investor » Fri Apr 05, 2019 6:59 pm

livesoft wrote:
Fri Apr 05, 2019 6:26 pm
vineviz wrote:
Fri Apr 05, 2019 6:21 pm
They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.
Also discussed in this thread on the Dividend Puzzle and a behavioral finance take on it:
viewtopic.php?t=233637

The linked article points to ERN's SWR series:
The Yield Illusion: How Can a High-Dividend Portfolio Exacerbate Sequence Risk? (SWR Series Part 29)

I suppose whenever the dividends vs total return thing comes up that I will just cut & paste this post into those threads.
Phineas J. Whoopee wrote:
Fri Apr 05, 2019 6:53 pm
If I may, total return does not mean, as claimed in the linked articles, spend the capital gains. Capital gains may be negative over any period of time. How does one negatively spend?

Gains have nothing to do with it. In total return one spends capital, which includes the value of the assets and any cash they throw off, all of which is capital.

I believe it's dangerously misleading to repeat the notion that in a total return strategy one spends "capital gains." One spends capital, and that is it, even if the person confines their spending to the portion of their capital represented by dividends.

PJW
Now whenever the dividends vs total return thing comes up, we can just cut & paste this summary post into those threads.

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Re: The "dividend preference anomaly"

Post by Dominic » Fri Apr 05, 2019 6:59 pm

vineviz wrote:
Fri Apr 05, 2019 6:21 pm
I've railed against the dividend fallacy often enough myself, but I also hold the belief that when your economic model says that people are consistently acting in an irrational way that the problem is more likely with your model than with the people.

In other words, I suspect it's highly likely that people who exhibit this ""dividend preference anomaly" aren't being irrational but rather that their utility function isn't well described by economists. In this case, for instance, I suspect that some investors are enjoying more utility from minimizing regret than by maximizing financial profit.

They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.

It's not too dissimilar from the discussion we have had about pensions vs annuities: many people like the idea of a annuitized income so long as someone else (e.g. their employer) decides on the parameters. Having to choose an annuity in the open market FEELS to them like a completely different realm, and they become cognizant that they might "choose wrong".
A very good point. Loss aversion is technically irrational, but it is so pervasive that models should account for it.

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Re: The "dividend preference anomaly"

Post by Phineas J. Whoopee » Fri Apr 05, 2019 7:02 pm

JustinR wrote:
Fri Apr 05, 2019 6:56 pm
...
I'd say you're overthinking it. I would say that 99% of investors simply think that dividends are free money or enjoy receiving money thinking they're richer.

Same exact thing with tax refunds. Most people love receiving it and complain when they don't because they're receiving money versus not receiving money.

Same exact thing.

I doubt even 1% of investors are comparing dividends to selling shares themselves.
I don't know what overthinking means, vis-a-vis the boundary between it and underthinking, but the fact, if indeed it is true, that many people make a fundamental mistake does not imply we shouldn't notice it and point it out, at least among ourselves.

PJW
Last edited by Phineas J. Whoopee on Fri Apr 05, 2019 7:12 pm, edited 1 time in total.

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Re: The "dividend preference anomaly"

Post by Phineas J. Whoopee » Fri Apr 05, 2019 7:05 pm

Dialectical Investor wrote:
Fri Apr 05, 2019 6:59 pm
livesoft wrote:
Fri Apr 05, 2019 6:26 pm
vineviz wrote:
Fri Apr 05, 2019 6:21 pm
They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.
Also discussed in this thread on the Dividend Puzzle and a behavioral finance take on it:
viewtopic.php?t=233637

The linked article points to ERN's SWR series:
The Yield Illusion: How Can a High-Dividend Portfolio Exacerbate Sequence Risk? (SWR Series Part 29)

I suppose whenever the dividends vs total return thing comes up that I will just cut & paste this post into those threads.
Phineas J. Whoopee wrote:
Fri Apr 05, 2019 6:53 pm
If I may, total return does not mean, as claimed in the linked articles, spend the capital gains. Capital gains may be negative over any period of time. How does one negatively spend?

Gains have nothing to do with it. In total return one spends capital, which includes the value of the assets and any cash they throw off, all of which is capital.

I believe it's dangerously misleading to repeat the notion that in a total return strategy one spends "capital gains." One spends capital, and that is it, even if the person confines their spending to the portion of their capital represented by dividends.

PJW
Now whenever the dividends vs total return thing comes up, we can just cut & paste this summary post into those threads.
That would save me a lot of time and effort. I probably expressed it better in this post earlier today.

PJW

Brian2d
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Re: The "dividend preference anomaly"

Post by Brian2d » Fri Apr 05, 2019 7:05 pm

I know there are a lot of high dividend index funds, but are there any low dividend index funds to tilt away from dividend payers? I'd consider using one to tilt my portfolio if it existed. I guess proof of dividend funds is that high dividend index funds are far more prevalent than their counterpart.

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Re: The "dividend preference anomaly"

Post by nisiprius » Fri Apr 05, 2019 7:15 pm

I'd like to know how many people who prefer dividend stocks actually do think of the dividends as free money. I'm sure that some do. Novice investors, listening to simplistic explanations, can easily get this idea.

Still, in the old terminology, it was fairly clear that "growth stocks" were the opposite of "dividend stocks," "widows-and-orphans" stocks. That is, it was understood that stocks that didn't pay dividends were expected to grow faster, which, if you turn it around, means that stocks that do pay dividends are expected to grow slower.

There are some other factors at work. One is simply the power of outdated thinking. In the days when "typical" retirement investors had portfolios of a dozen or so individual stocks, rather than a mutual fund, dividends were the only practical way to get an income stream, because the friction involved in buying or selling small quantities of stock made it impractical. The typical brokerage fee for even the smallest transaction was on the rough order of $100. Anything that wasn't a round lot of 100 shares went through a special broker that deducted 1/8th from every sale--the fee was hidden in a fictitious price, if the true market price was 50, your confirmation slip said you'd sold them at 49-7/8th. So this established a habit that the way to get income from stocks was to create a portfolio of dividend payers, "widows and orphans stocks." (The reverse of this was a preference for buying stocks with "DRIP" options, "dividend reinvestment plans.")

The majority of dividend enthusiasts in the forum don't believe dividends are free money. They seem to fall into two categories. One is people who believe that, perhaps because the influence of dividend payments keeps corporation managers honest, dividend stocks are a just plain superior category of stock--total return, risk-adjusted reward, and all.

The second, and I'm somewhat sympathetic to this, is "dividends as an SWR method." The point here is that someone--someone who is not you--has chosen the dividend payments with the idea that they are sustainable. Therefore, "spending the dividends" is safe--it won't ever run your portfolio down to zero--and even with the drag of dividends, the stocks (and thus the dividend stream) might grow with inflation. Second, dividends exhibit some lag, some moving average effect--if a stock falls to 50% of its former market value, dividends, in dollars, don't fall 50% immediately. They behave rather like the payouts from Vanguard Managed Payout, in which the payments are smoothed out by means of the three-year moving average.
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Re: The "dividend preference anomaly"

Post by Angst » Fri Apr 05, 2019 7:31 pm

vineviz wrote:
Fri Apr 05, 2019 6:21 pm
CULater wrote:
Fri Apr 05, 2019 6:09 pm
Article describing investor preference for dividend stocks as an "anomaly." This is also Larry Swedroe's view.
A good many retirees seem to be enamored with the "Spend Interest and Dividends Only" strategy for spending down their retirement savings. The foundation of this strategy is a preference for the value of a dollar generated from dividends over the value of a dollar generated from the sale of stock, or capital gains.

This preference has long been recognized but never quite understood.

...dividends fall under the category of mental accounting. ...a "free dividend fallacy", in which investors view dividends as a source of return that is independent of the price of the stock when in reality the price of the stock is immediately reduced by the value of the dividend when it is paid. This fosters the mistaken belief that dividends are the same as bond interest.
http://www.theretirementcafe.com
I've railed against the dividend fallacy often enough myself, but I also hold the belief that when your economic model says that people are consistently acting in an irrational way that the problem is more likely with your model than with the people.

In other words, I suspect it's highly likely that people who exhibit this ""dividend preference anomaly" aren't being irrational but rather that their utility function isn't well described by economists. In this case, for instance, I suspect that some investors are enjoying more utility from minimizing regret than by maximizing financial profit.

They are - explicitly or implicitly - willing to pay a small premium in terms of total return to avoid the feeling of regret triggered by selling (or having to decide whether to sell) a stock in an uncomfortable market environment.

It's not too dissimilar from the discussion we have had about pensions vs annuities: many people like the idea of a annuitized income so long as someone else (e.g. their employer) decides on the parameters. Having to choose an annuity in the open market FEELS to them like a completely different realm, and they become cognizant that they might "choose wrong".
I think I'm in agreement with vineviz on this as well, although I'm inclined to say that the side of the coin that represents simple ignorance turns up more frequently than the other.
Last edited by Angst on Fri Apr 05, 2019 7:33 pm, edited 1 time in total.

UpperNwGuy
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Re: The "dividend preference anomaly"

Post by UpperNwGuy » Fri Apr 05, 2019 7:32 pm

Long before I started investing, I used to hear that their were two kinds of stock that were superior to other stocks: Blue Chip stocks and stocks that paid high dividends. I had to unlearn these popular beliefs once I started investing.

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Re: The "dividend preference anomaly"

Post by willthrill81 » Fri Apr 05, 2019 7:39 pm

petulant wrote:
Fri Apr 05, 2019 6:22 pm
Is there any evidence one could exploit this fallacy by focusing on non-dividend stocks to earn alpha? If not, why not?
I don't believe so. For some inexplicable reason, it seems that betting on the opposite side of a fallacy doesn't necessarily result in alpha. Nisiprius has posted about this before. Perhaps he'll weigh in.
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Re: The "dividend preference anomaly"

Post by trueblueky » Fri Apr 05, 2019 7:42 pm

In a taxable account, one is taxed on the dividends. A quarterly dividend check is predictable and requires no action by the taxpayer.

Say to that retiree: Forget dividends, sell the capital. Worry about wash sales and timing. Keep track of specific lots.

That sure sounds harder.

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Re: The "dividend preference anomaly"

Post by willthrill81 » Fri Apr 05, 2019 7:53 pm

trueblueky wrote:
Fri Apr 05, 2019 7:42 pm
In a taxable account, one is taxed on the dividends. A quarterly dividend check is predictable and requires no action by the taxpayer.

Say to that retiree: Forget dividends, sell the capital. Worry about wash sales and timing. Keep track of specific lots.

That sure sounds harder.
Why would a retiree who is only selling worry about wash sales? If you're not a market timer, would you worry about timing? Just create your own 'dividend' by selling when needed.
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Re: The "dividend preference anomaly"

Post by AlohaJoe » Fri Apr 05, 2019 8:01 pm

trueblueky wrote:
Fri Apr 05, 2019 7:42 pm
Say to that retiree: Forget dividends, sell the capital. Worry about wash sales and timing. Keep track of specific lots.
In the past that would have been true but nowadays computers easily do all of that. All a retiree has to do is a click a button saying "send me $5,000 a month".

I think nowadays every broker offers this, though unfortunately it is often only part of their robo-advisor service. Hopefully that'll change in the future.

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Re: The "dividend preference anomaly"

Post by hirlaw » Fri Apr 05, 2019 8:29 pm

At least from my experience, most dividend investors do not even realize that the stock price is marked down by the amount of the dividend paid. So, many are not taking this critical fact into account when preferring dividends over selling shares. However, I believe that many, even if they were aware of all of the facts, would still prefer dividends because of the convenience of automatic payments.

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Re: The "dividend preference anomaly"

Post by rkhusky » Fri Apr 05, 2019 8:49 pm

If there were no companies that paid a dividend and did not ever intend to pay a dividend, then owning stock would be no different than owning a painting or a Rolex or a bar of gold.

I would rather receive a dividend than have the company use its spare cash to enrich its executives or build fancier offices.

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Re: The "dividend preference anomaly"

Post by RAchip » Fri Apr 05, 2019 9:04 pm

“most dividend investors do not even realize that the stock price is marked down by the amount of the dividend paid“

Do you know how the prices at which stocks on the NYSE actually trade are determined? What is it that you claim is “marked down”, the bid or the ask? Who do you claim does this “marking down”? In fact, prices are set by supply and demand. If you put an order in to sell some shares of a company the day after the ex dividend at the closing price the day before the ex dividend, that order may or may not be filled depending on supply and demand. Even if the bid price falls by the amount of a dividend right after ex dividend, there may be no trades at all at that price. A stock may well trade in the days after after ex dividend at prices in excess of the trading prices prior to ex dividend.

The fact of the matter is that the market does not receive daily disclosure of a company’s cash position so cash holdings of a company usually have a relatively limited impact on daily trade prices.

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Re: The "dividend preference anomaly"

Post by munemaker » Fri Apr 05, 2019 9:08 pm

Public companies who pay common stock dividends are different than companies who do not pay dividends.

Companies that pay dividends are generally larger, mature companies that do not need to reinvest the money in the growth of the company.

Companies that do not pay dividends generally are growing and can find ways to use the money to expand the company.

The preference may go beyond the dividend itself. It may be a preference for more mature, stable companies that may tend to be more value oriented than growth oriented.

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Re: The "dividend preference anomaly"

Post by UsualLine » Fri Apr 05, 2019 9:22 pm

RAchip wrote:
Fri Apr 05, 2019 9:04 pm
“most dividend investors do not even realize that the stock price is marked down by the amount of the dividend paid“

Do you know how the prices at which stocks on the NYSE actually trade are determined? What is it that you claim is “marked down”, the bid or the ask? Who do you claim does this “marking down”? In fact, prices are set by supply and demand. If you put an order in to sell some shares of a company the day after the ex dividend at the closing price the day before the ex dividend, that order may or may not be filled depending on supply and demand. Even if the bid price falls by the amount of a dividend right after ex dividend, there may be no trades at all at that price. A stock may well trade in the days after after ex dividend at prices in excess of the trading prices prior to ex dividend.

The fact of the matter is that the market does not receive daily disclosure of a company’s cash position so cash holdings of a company usually have a relatively limited impact on daily trade prices.
There is an ex-dividend date after which the owner of the stock will not receive the dividend. If the stock were not "marked down" on that date, then the obvious thing to do would be to buy the day before and sell the day after at the same price and pocket the dividend.

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Re: The "dividend preference anomaly"

Post by pdavi21 » Fri Apr 05, 2019 9:37 pm

There were differences in companies that paid steady increasing dividends in the past. I suppose that's been changing, but there is still a difference in a company that is capable and/or has to resort to paying high dividends and/or stock repurchases.
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Re: The "dividend preference anomaly"

Post by trueblueky » Fri Apr 05, 2019 9:49 pm

willthrill81 wrote:
Fri Apr 05, 2019 7:53 pm
trueblueky wrote:
Fri Apr 05, 2019 7:42 pm
In a taxable account, one is taxed on the dividends. A quarterly dividend check is predictable and requires no action by the taxpayer.

Say to that retiree: Forget dividends, sell the capital. Worry about wash sales and timing. Keep track of specific lots.

That sure sounds harder.
Why would a retiree who is only selling worry about wash sales? If you're not a market timer, would you worry about timing? Just create your own 'dividend' by selling when needed.
If the retiree is reinvesting dividends, isn't there the possibility of wash sales? The wiki seems to indicate it does.
https://www.bogleheads.org/wiki/Wash_sale

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Re: The "dividend preference anomaly"

Post by willthrill81 » Fri Apr 05, 2019 10:27 pm

trueblueky wrote:
Fri Apr 05, 2019 9:49 pm
willthrill81 wrote:
Fri Apr 05, 2019 7:53 pm
trueblueky wrote:
Fri Apr 05, 2019 7:42 pm
In a taxable account, one is taxed on the dividends. A quarterly dividend check is predictable and requires no action by the taxpayer.

Say to that retiree: Forget dividends, sell the capital. Worry about wash sales and timing. Keep track of specific lots.

That sure sounds harder.
Why would a retiree who is only selling worry about wash sales? If you're not a market timer, would you worry about timing? Just create your own 'dividend' by selling when needed.
If the retiree is reinvesting dividends, isn't there the possibility of wash sales? The wiki seems to indicate it does.
https://www.bogleheads.org/wiki/Wash_sale
Dividends are not sales, so there's no possibility of a wash sale occurring, AFAIK.

But with only a 2% dividend yield (i.e. for VTSAX), why would you be reinvesting dividends if you're in the withdrawal phase? Spend them! :D
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Re: The "dividend preference anomaly"

Post by Dialectical Investor » Fri Apr 05, 2019 10:44 pm

willthrill81 wrote:
Fri Apr 05, 2019 10:27 pm

Dividends are not sales, so there's no possibility of a wash sale occurring, AFAIK.

But with only a 2% dividend yield (i.e. for VTSAX), why would you be reinvesting dividends if you're in the withdrawal phase? Spend them! :D
The wash sale would occur if you reinvested the distribution and subsequently sold at a loss within 30 days of the distribution. This may be avoidable, and even if not, is probably of no great monetary consequence and is more of a paperwork issue. And, as you said, if you need to sell shares for more cash than the dividends would provide, you probably aren't reinvesting your dividends anyway. There is added complexity if you own a substantially identical fund in a different account.

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Re: The "dividend preference anomaly"

Post by AerialWombat » Fri Apr 05, 2019 11:04 pm

munemaker wrote:
Fri Apr 05, 2019 9:08 pm
The preference may go beyond the dividend itself. It may be a preference for more mature, stable companies that may tend to be more value oriented than growth oriented.
Bingo. For me, at least.

Too much of my “fuzzy” net worth is locked up in a tech startup that I co-founded. For the 30% of my liquid securities that are in equities, I want old, mature, stable, boring companies and other “non-correlated” assets. Thus, I have a hefty dividend fund tilt and a REIT tilt.
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Re: The "dividend preference anomaly"

Post by willthrill81 » Fri Apr 05, 2019 11:07 pm

munemaker wrote:
Fri Apr 05, 2019 9:08 pm
The preference may go beyond the dividend itself. It may be a preference for more mature, stable companies that may tend to be more value oriented than growth oriented.
To the extent that markets are efficient, why should that matter, unless you're pursuing a value tilt, in which case there seem to be better means of identifying such companies than on the basis of dividends?
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Re: The "dividend preference anomaly"

Post by DonIce » Fri Apr 05, 2019 11:13 pm

willthrill81 wrote:
Fri Apr 05, 2019 11:07 pm
munemaker wrote:
Fri Apr 05, 2019 9:08 pm
The preference may go beyond the dividend itself. It may be a preference for more mature, stable companies that may tend to be more value oriented than growth oriented.
To the extent that markets are efficient, why should that matter, unless you're pursuing a value tilt, in which case there seem to be better means of identifying such companies than on the basis of dividends?
If value, momentum, growth, quality, volatility, size, and dozens of other things can be "factors" that people "tilt" towards then why can't dividends? Seems like companies that pay out cash instead of reinvesting in themselves and thereby miss opportunities to grow is a risk that ought to be compensated. Same for the risk of lower returns due to the disadvantageous tax treatment of dividends! That's about as strong as the arguments for other "factors".

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Re: The "dividend preference anomaly"

Post by willthrill81 » Fri Apr 05, 2019 11:17 pm

DonIce wrote:
Fri Apr 05, 2019 11:13 pm
willthrill81 wrote:
Fri Apr 05, 2019 11:07 pm
munemaker wrote:
Fri Apr 05, 2019 9:08 pm
The preference may go beyond the dividend itself. It may be a preference for more mature, stable companies that may tend to be more value oriented than growth oriented.
To the extent that markets are efficient, why should that matter, unless you're pursuing a value tilt, in which case there seem to be better means of identifying such companies than on the basis of dividends?
If value, momentum, growth, quality, volatility, size, and dozens of other things can be "factors" that people "tilt" towards then why can't dividends? Seems like companies that pay out cash instead of reinvesting in themselves and thereby miss opportunities to grow is a risk that ought to be compensated. Same for the risk of lower returns due to the disadvantageous tax treatment of dividends! That's about as strong as the arguments for other "factors".
IIRC, research has shown that when you account for the value tilt of dividend stocks, their historic returns were no better than the market's.
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Re: The "dividend preference anomaly"

Post by DonIce » Fri Apr 05, 2019 11:28 pm

willthrill81 wrote:
Fri Apr 05, 2019 11:17 pm
IIRC, research has shown that when you account for the value tilt of dividend stocks, their historic returns were no better than the market's.
I have serious reservations about the idea that ~100 years of market history can be enough to tease out these kinds of differences in a way that has any useful predictive capability. When you start trying to categorize companies on ~10 different dimensions (their exposure to market beta, size premium, value premium, quality, volatility, growth, momentum, etc) to predict their future returns, you're probably just better off trying to look at the actual details of the company instead like its balance sheet, business prospects, management team, etc.

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Re: The "dividend preference anomaly"

Post by Dialectical Investor » Fri Apr 05, 2019 11:38 pm

DonIce wrote:
Fri Apr 05, 2019 11:13 pm

If value, momentum, growth, quality, volatility, size, and dozens of other things can be "factors" that people "tilt" towards then why can't dividends? Seems like companies that pay out cash instead of reinvesting in themselves and thereby miss opportunities to grow is a risk that ought to be compensated. Same for the risk of lower returns due to the disadvantageous tax treatment of dividends! That's about as strong as the arguments for other "factors".
Sure dividends can be a factor. Anything can be a factor, really, though it won't withstand scrutiny without a supporting qualitative explanation. Then there is a focus on reducing the number of factors, so if dividends plus a few other factors can be explained by one other factor, like value, as mentioned, value is going to win as a determinable factor. In the future, dividends plus some other factor may explain returns better than three of the previous "superior" factors, thus becoming the new determinable factors. I doubt it though. :|

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Re: The "dividend preference anomaly"

Post by DonIce » Fri Apr 05, 2019 11:50 pm

Factors remind me of all the work done by astronomers prior to the development the Copernican view of the solar system and the theory of gravity. The paths of the planets weren't quite perfectly circular, as ancient philosophers had assumed would be the case in the geocentric model, so they used hundreds of years of data to characterize their "epicycles", little sub-circles that the planets had to follow to explain their observed motion.

https://en.wikipedia.org/wiki/Deferent_ ... le#History

Epicycles at least had predictive power that was fairly reliable though, which is more than can be said for present models of the financial markets.

Markets are inherently non-deterministic and I don't find the qualitative "risk stories" behind factors at all convincing. The division of which kinds of risk ought to be compensated by the markets and which ought not to be seem entirely arbitrary.

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Re: The "dividend preference anomaly"

Post by Dialectical Investor » Sat Apr 06, 2019 12:02 am

DonIce wrote:
Fri Apr 05, 2019 11:50 pm

Markets are inherently non-deterministic and I don't find the qualitative "risk stories" behind factors at all convincing. The division of which kinds of risk ought to be compensated by the markets and which ought not to be seem entirely arbitrary.
Don't worry. If the model turns out to be wrong enough long enough, there will be a new model. :P

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Re: The "dividend preference anomaly"

Post by DonIce » Sat Apr 06, 2019 12:10 am

Dialectical Investor wrote:
Sat Apr 06, 2019 12:02 am
Don't worry. If the model turns out to be wrong enough long enough, there will be a new model. :P
Yes, it all makes for plenty of fodder for PhDs but not so much in terms of actionable information.

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Re: The "dividend preference anomaly"

Post by Dialectical Investor » Sat Apr 06, 2019 12:27 am

DonIce wrote:
Sat Apr 06, 2019 12:10 am
Dialectical Investor wrote:
Sat Apr 06, 2019 12:02 am
Don't worry. If the model turns out to be wrong enough long enough, there will be a new model. :P
Yes, it all makes for plenty of fodder for PhDs but not so much in terms of actionable information.
You have to consider the questions the analysis is trying to address. If the analysis is trying to take all the many hundreds/thousands of potential variables and distill them down to a manageable handful of factors to explain the performance of the parts of a whole, of course someone who is only interested in the whole is not going to care very much about the parts, nor find it very actionable. I would guess that includes a lot of people on this forum. But, I would say the information is certainly actionable to this thread, as it can provide a basis on which to debate the question of whether or not dividends help determine stock performance. There are other ways to attempt to answer that question, of course, but heuristic methods seem to be a failure. Hence, a model.

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Re: The "dividend preference anomaly"

Post by 3504PIR » Sat Apr 06, 2019 12:37 am

I disagree with the selling shares is the same as taking dividends argument purely from the worst case scenario point of view. In a long term negative return environment, selling shares can be catastrophic to a portfolio. Other than that, in a positive return environment I think it’s apples to apples.

My personal takeaway from the Great Recession was that I was happy the markets recovered the way they did, but there is no guarantee that they will in the future. I read thousands of posts here that fundamentally assume that the markets will always recover in a similar manner, but don’t ever recall reading a post where it is assumed that a recovery could take decades.

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Re: The "dividend preference anomaly"

Post by JustinR » Sat Apr 06, 2019 2:19 am

3504PIR wrote:
Sat Apr 06, 2019 12:37 am
I disagree with the selling shares is the same as taking dividends argument purely from the worst case scenario point of view. In a long term negative return environment, selling shares can be catastrophic to a portfolio.
...How? It's exactly the same thing.

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Re: The "dividend preference anomaly"

Post by UKFred » Sat Apr 06, 2019 2:36 am

I have a theory: if you think that you own 100 shares of Apple, the price of which bounces up and down in ways that you cannot predict or control, spending a dividend makes sense (psychologically) because you haven’t lost anything when you do so. You still own 100 shares of Apple.

Moving on from psychology, the thing about dividend preference is that it may not be optimal, but it is a technique that actually works in real life. If you restrict yourself to spending dividends, your withdrawal rate is low and your portfolio will last your lifetime and will even grow over the years (May be not as much as the total market, but it probably will grow). For someone who is not very savvy about markets and scared that they will make a mistake that jeopardises their retirement, this is a big thing.

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Re: The "dividend preference anomaly"

Post by 3504PIR » Sat Apr 06, 2019 4:38 am

JustinR wrote:
Sat Apr 06, 2019 2:19 am
3504PIR wrote:
Sat Apr 06, 2019 12:37 am
I disagree with the selling shares is the same as taking dividends argument purely from the worst case scenario point of view. In a long term negative return environment, selling shares can be catastrophic to a portfolio.
...How? It's exactly the same thing.
Do the math. Take a period of time that you consider long term, 10, 15, 20 years for example, in a negative return environment annually and do the math of selling shares vs not selling shares and then post the value of each at the end. I can guarantee you that it’s not the same. Alternate annual performance with a couple of low positive return years and a couple of zero return years and the rest negative return years, even just a few % down, and its still not the same. You will have fewer shares worth fewer dollars.

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Re: The "dividend preference anomaly"

Post by Silverado » Sat Apr 06, 2019 5:41 am

3504PIR wrote:
Sat Apr 06, 2019 4:38 am
JustinR wrote:
Sat Apr 06, 2019 2:19 am
3504PIR wrote:
Sat Apr 06, 2019 12:37 am
I disagree with the selling shares is the same as taking dividends argument purely from the worst case scenario point of view. In a long term negative return environment, selling shares can be catastrophic to a portfolio.
...How? It's exactly the same thing.
Do the math. Take a period of time that you consider long term, 10, 15, 20 years for example, in a negative return environment annually and do the math of selling shares vs not selling shares and then post the value of each at the end. I can guarantee you that it’s not the same. Alternate annual performance with a couple of low positive return years and a couple of zero return years and the rest negative return years, even just a few % down, and its still not the same. You will have fewer shares worth fewer dollars.
You may want to check your reserve chute.

if you want to persuade someone, you should do the math and post it. Especially when the math has been posted to support the position numerous times. Taking $10 out is taking $10 out, regardless of method, regardless of number of times. Ignoring taxes of course.

Edited to add: reread it and my response seems snarky with the opening line. Not meant to be, just acknowledging your username. Read it with soft tone...

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Re: The "dividend preference anomaly"

Post by grayfox » Sat Apr 06, 2019 5:57 am

CULater wrote:
Fri Apr 05, 2019 6:09 pm
Article describing investor preference for dividend stocks as an "anomaly." This is also Larry Swedroe's view.
...dividends fall under the category of mental accounting. ...a "free dividend fallacy", in which investors view dividends as a source of return that is independent of the price of the stock when in reality the price of the stock is immediately reduced by the value of the dividend when it is paid. This fosters the mistaken belief that dividends are the same as bond interest.
http://www.theretirementcafe.com
What does "the price of the stock is immediately reduced by the value of the dividend when it is paid" mean? Which stock price?
RAchip wrote:
Fri Apr 05, 2019 9:04 pm
“most dividend investors do not even realize that the stock price is marked down by the amount of the dividend paid

Do you know how the prices at which stocks on the NYSE actually trade are determined? What is it that you claim is “marked down”, the bid or the ask? Who do you claim does this “marking down”? In fact, prices are set by supply and demand. If you put an order in to sell some shares of a company the day after the ex dividend at the closing price the day before the ex dividend, that order may or may not be filled depending on supply and demand. Even if the bid price falls by the amount of a dividend right after ex dividend, there may be no trades at all at that price. A stock may well trade in the days after after ex dividend at prices in excess of the trading prices prior to ex dividend.

The fact of the matter is that the market does not receive daily disclosure of a company’s cash position so cash holdings of a company usually have a relatively limited impact on daily trade prices.
Can anyone explain how "the stock price is marked down by the amount of the dividend paid." Again, which stock price? Bid? Ask? And when is it marked down?

Can someone explain to me exactly what happens to stock prices when a dividend is paid?

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Re: The "dividend preference anomaly"

Post by JustinR » Sat Apr 06, 2019 6:15 am

3504PIR wrote:
Sat Apr 06, 2019 4:38 am
JustinR wrote:
Sat Apr 06, 2019 2:19 am
3504PIR wrote:
Sat Apr 06, 2019 12:37 am
I disagree with the selling shares is the same as taking dividends argument purely from the worst case scenario point of view. In a long term negative return environment, selling shares can be catastrophic to a portfolio.
...How? It's exactly the same thing.
Do the math. Take a period of time that you consider long term, 10, 15, 20 years for example, in a negative return environment annually and do the math of selling shares vs not selling shares and then post the value of each at the end. I can guarantee you that it’s not the same. Alternate annual performance with a couple of low positive return years and a couple of zero return years and the rest negative return years, even just a few % down, and its still not the same. You will have fewer shares worth fewer dollars.
Have you done the math?


Start with 1 share of $100

A) $10 dividend is distributed. You now have 1 share of $90 = $90
B) You sell $10 worth of shares. You now have .9 shares of $100 = $90


Notice that the result is exactly the same: you have $10 in your bank account and $90 in your Vanguard account.
This year the stock goes down 50%.

A) You now have 1 share of $45 = $45
B) You now have .9 shares of $50 = $45


Distribute another dividend/sell $10.

A) Dividend: You now have 1 share of $35 = $35
B) Sell: You now have .778 shares of $45 = $35


This year the stock goes up 20%.

A) You now have 1 share of $42 = $42
B) You now have .778 shares of $54 = $42


And so on and so forth.


Dividends and selling shares yourself are the exact same thing.

The fact that there's people in this thread that still can't accept this basic fact proves the point of this thread.
Last edited by JustinR on Sat Apr 06, 2019 6:50 am, edited 5 times in total.

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Re: The "dividend preference anomaly"

Post by livesoft » Sat Apr 06, 2019 6:30 am

grayfox wrote:
Sat Apr 06, 2019 5:57 am

Can anyone explain how "the stock price is marked down by the amount of the dividend paid." Again, which stock price? Bid? Ask? And when is it marked down?

Can someone explain to me exactly what happens to stock prices when a dividend is paid?
There is a wiki article on that:
Why did my fund unexpectedly drop in value?
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Re: The "dividend preference anomaly"

Post by dkturner » Sat Apr 06, 2019 6:50 am

petulant wrote:
Fri Apr 05, 2019 6:22 pm
Is there any evidence one could exploit this fallacy by focusing on non-dividend stocks to earn alpha? If not, why not?
Actually, history suggests that dividend paying stocks produce higher total returns than non-dividend paying stocks, and they do so with lower volatility. In this regard take a look at Kenneth French’s Dartmouth College website.

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Re: The "dividend preference anomaly"

Post by dkturner » Sat Apr 06, 2019 7:09 am

grayfox wrote:
Sat Apr 06, 2019 5:57 am
Can someone explain to me exactly what happens to stock prices when a dividend is paid?
Nothing special happens to the price of any particular stock on the day it’s dividend is paid. On average a stock drops in price by the amount of its dividend on the day the stock begins to trade ex-dividend though.

The reason that investors argue about the existence of this decline in price until they’re blue in the face is because the decline due to the impending dividend payment is only one of the myriad factors that affect the price of a stock on the ex-dividend day. You can see the pure ex-dividend effect with an open-end mutual fund on its ex-dividend day. With individual stocks the picture is not as clear. Some dividend proponents are so ignorant that they actually believe they can avoid the ex-dividend decline by investing in individual stocks rather than mutual funds.

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Re: The "dividend preference anomaly"

Post by The Wizard » Sat Apr 06, 2019 7:41 am

RAchip wrote:
Fri Apr 05, 2019 9:04 pm
“most dividend investors do not even realize that the stock price is marked down by the amount of the dividend paid“

Do you know how the prices at which stocks on the NYSE actually trade are determined? What is it that you claim is “marked down”, the bid or the ask? Who do you claim does this “marking down”? In fact, prices are set by supply and demand...
Correct.
One could even extend this to the ludicrous conclusion that if Proctor and Gamble doesn't stop paying quarterly dividends, its stock price will eventually go to zero.

Fact is, a mature consumer product company accumulates profits on a daily or weekly basis. There would be too much overhead expense to share those profits with owners every week, so every three months is a good compromise...
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Re: The "dividend preference anomaly"

Post by The Wizard » Sat Apr 06, 2019 7:53 am

dkturner wrote:
Sat Apr 06, 2019 6:50 am
petulant wrote:
Fri Apr 05, 2019 6:22 pm
Is there any evidence one could exploit this fallacy by focusing on non-dividend stocks to earn alpha? If not, why not?
Actually, history suggests that dividend paying stocks produce higher total returns than non-dividend paying stocks, and they do so with lower volatility. In this regard take a look at Kenneth French’s Dartmouth College website.
I was going to ask this question.
So if dividend paying stocks as a group have higher Total Return that non dividend paying stocks, then it's easy to put together a mutual fund to take advantage of this and outperform the dull old Total Stock Market fund year after year.
Right?
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