Something Jack said in Common Sense

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
Defiantslave
Posts: 5
Joined: Sat Aug 01, 2020 6:03 pm

Something Jack said in Common Sense

Post by Defiantslave » Sat Aug 01, 2020 6:08 pm

Active funds soak up all your dividend income.

Its the one section in the book that completely confounds me everytime I listen.... I understand the costs. But someone explain what he was talking about here to me like I was 5 haha.

Thanks everyone!

000
Posts: 831
Joined: Thu Jul 23, 2020 12:04 am

Re: Something Jack said in Common Sense

Post by 000 » Sat Aug 01, 2020 6:14 pm

Funds take the ER (expense ratio) out of the dividends.

If your active fund has 1% ER and is invested in stocks paying 1.7% dividends, the fund takes 1/1.7 == 58.8% of your dividends.
Last edited by 000 on Sat Aug 01, 2020 6:18 pm, edited 1 time in total.

Broken Man 1999
Posts: 4717
Joined: Wed Apr 08, 2015 11:31 am
Location: West coast of Florida, inland on high ground!

Re: Something Jack said in Common Sense

Post by Broken Man 1999 » Sat Aug 01, 2020 6:16 pm

Defiantslave wrote:
Sat Aug 01, 2020 6:08 pm
Active funds soak up all your dividend income.

Its the one section in the book that completely confounds me everytime I listen.... I understand the costs. But someone explain what he was talking about here to me like I was 5 haha.

Thanks everyone!
High ER expense funds might indeed suck up a lot of dividends, but it is also true that some active funds at Vanguard have worked out very well. They don't all sport high ERs.

So, the right answer is maybe, or maybe not. Active funds are not all the same.

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven then I shall not go. " -Mark Twain

User avatar
nisiprius
Advisory Board
Posts: 41374
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Something Jack said in Common Sense

Post by nisiprius » Sat Aug 01, 2020 6:20 pm

It's not literally true, he's saying that costs of typical active funds are in the same ballpark as the dividends collectively paid by the stocks in the fund. It's a way of looking at how big the expenses are.
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.

Topic Author
Defiantslave
Posts: 5
Joined: Sat Aug 01, 2020 6:03 pm

Re: Something Jack said in Common Sense

Post by Defiantslave » Sat Aug 01, 2020 6:20 pm

If it was as simple as an ER of 1 and he was taking that out of the dividend yield, I get it. I thought he's implying a HIDDEN cost.....

000
Posts: 831
Joined: Thu Jul 23, 2020 12:04 am

Re: Something Jack said in Common Sense

Post by 000 » Sat Aug 01, 2020 6:21 pm

Defiantslave wrote:
Sat Aug 01, 2020 6:20 pm
If it was as simple as an ER of 1 and he was taking that out of the dividend yield, I get it. I thought he's implying a HIDDEN cost.....
The "hidden" aspect is some people do comparisons to indices EXCLUDING dividends, instead of an index fund with dividends reinvested. In other words, some people ignore the dividend issue.

Topic Author
Defiantslave
Posts: 5
Joined: Sat Aug 01, 2020 6:03 pm

Re: Something Jack said in Common Sense

Post by Defiantslave » Sat Aug 01, 2020 6:23 pm

OK perfect. I like discussing this stuff with friends and family but I was careful not to talk about the dividend issue, because I thought I was missing a fundamental here. Appreciate the clarification.

Boglegrappler
Posts: 1276
Joined: Wed Aug 01, 2012 9:24 am

Re: Something Jack said in Common Sense

Post by Boglegrappler » Sat Aug 01, 2020 6:59 pm

Funds take the ER (expense ratio) out of the dividends.

If your active fund has 1% ER and is invested in stocks paying 1.7% dividends, the fund takes 1/1.7 == 58.8% of your dividends.
This is a way of looking at it, but it invites a false implication. In the way it is described, you would expect to receive only 41.2% of the dividends your funds underlying investments generated. That isn't what happens. You'll be paid all of the underlying dividends, but the fund will also make a payment to the management company that will not explicitly be visible to you from your daily statements. It will in effect come out of net asset value because the fund will have to sell some of your assets to pay themselves.

It would, of course, have the same economic effect if they paid themselves by reducing your dividend and keeping some for themselves, but it would make the expense much more apparent. Bogle's way of explaining it (by relating it to dividends) is simply to emphasize how high a 1% expense ratio is in a market environment where stocks only generate current income of less than 2%.

000
Posts: 831
Joined: Thu Jul 23, 2020 12:04 am

Re: Something Jack said in Common Sense

Post by 000 » Sat Aug 01, 2020 7:07 pm

Boglegrappler wrote:
Sat Aug 01, 2020 6:59 pm
Funds take the ER (expense ratio) out of the dividends.

If your active fund has 1% ER and is invested in stocks paying 1.7% dividends, the fund takes 1/1.7 == 58.8% of your dividends.
This is a way of looking at it, but it invites a false implication. In the way it is described, you would expect to receive only 41.2% of the dividends your funds underlying investments generated. That isn't what happens. You'll be paid all of the underlying dividends, but the fund will also make a payment to the management company that will not explicitly be visible to you from your daily statements. It will in effect come out of net asset value because the fund will have to sell some of your assets to pay themselves.

It would, of course, have the same economic effect if they paid themselves by reducing your dividend and keeping some for themselves, but it would make the expense much more apparent. Bogle's way of explaining it (by relating it to dividends) is simply to emphasize how high a 1% expense ratio is in a market environment where stocks only generate current income of less than 2%.
Vanguard Windsor Investor Shares 0.30% ER 2.11% SEC Yield
Vanguard Windsor Admiral Shares 0.20% ER 2.21% SEC Yield
0.30 - 0.20 == 2.21 - 2.11 == 0.10

User avatar
abuss368
Posts: 20412
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!
Contact:

Re: Something Jack said in Common Sense

Post by abuss368 » Sat Aug 01, 2020 7:24 pm

One of the best Jack Bogle books I ever read!
John C. Bogle: Two Fund Portfolio - Total Stock & Total Bond - “Simplicity is the master key to financial success."

User avatar
Taylor Larimore
Advisory Board
Posts: 29691
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Re: Something Jack said in Common Sense

Post by Taylor Larimore » Sat Aug 01, 2020 7:45 pm

Defiantslave wrote:
Sat Aug 01, 2020 6:08 pm
Active funds soak up all your dividend income.

Its the one section in the book that completely confounds me everytime I listen.... I understand the costs. But someone explain what he was talking about here to me like I was 5 haha.

Thanks everyone!
Defiantslave:

Please give us the page number and which edition of "Common Sense on Mutual Funds" has the quote that "confounds" you. I could not find it.

Thank you and best wishes.

Taylor
Jack Bogle's Words of Wisdom: "If you are an equity fund shareholder, the tax situation with respect to income dividends is no different from the treatment of bond interest.[/b]
"Simplicity is the master key to financial success." -- Jack Bogle

Topic Author
Defiantslave
Posts: 5
Joined: Sat Aug 01, 2020 6:03 pm

Re: Something Jack said in Common Sense

Post by Defiantslave » Sat Aug 01, 2020 8:16 pm

I'm not sure... I've listened to the audiobook 30 times haha.... Its near the end when he's talking about dividend rates

Topic Author
Defiantslave
Posts: 5
Joined: Sat Aug 01, 2020 6:03 pm

Re: Something Jack said in Common Sense

Post by Defiantslave » Sat Aug 01, 2020 8:17 pm

No problem though.... I'm getting the idea now from everyone else's response

User avatar
Svensk Anga
Posts: 709
Joined: Sun Dec 23, 2012 5:16 pm

Re: Something Jack said in Common Sense

Post by Svensk Anga » Sat Aug 01, 2020 9:21 pm

Defiantslave wrote:
Sat Aug 01, 2020 6:20 pm
If it was as simple as an ER of 1 and he was taking that out of the dividend yield, I get it. I thought he's implying a HIDDEN cost.....
There are indeed hidden costs. Elsewhere in the book, Jack discusses the costs arising from trading activity which can be especially severe in active funds. The funds pay the bid-ask spread as they trade and they pay commissions to the brokers handing their trades. IIRC, Jack estimated this at about 1% of expense for every 100%/year turnover. These costs are not part of the expense ratio. If you have an active fund with 1% trading costs and 1% ER, it can indeed wipe out a 2% dividend yield. It does not look this way to the investor however. He will probably still get the 1% of dividends net of the ER. The other 1%/year is a drain on the fund NAV.

Index funds trade very little. The broader-based index they follow, the less they have to trade to track the index. Narrow index funds have to trade more as securities move in and out of the index. Think total stock market funds versus small cap value for instance. Less trading means less hidden cost. Check the fund turnover ratio for an idea of the magnitude of the hidden cost. Some active funds have low turnover. Last I looked Vanguard Primecap turned over at 7%/year.

Post Reply