[Editor's Note: The following article originally ran as one of my regular columns over at Forbes and looks at the problems investors face when they place too much emphasis on investing in dividend stocks over using low-cost, broadly diverse index funds. Enjoy!]
Through my work at The White Coat Investor where I help high-income professionals to get a “fair shake” on Wall Street, I have run into many investors who inappropriately focus their investments on dividend-paying stocks. While there are far worse ways to invest, a focus on dividend-paying stocks has an almost cult-like following. There are five reasons why overly focusing on investing in dividend stocks is generally an investing error.
# 1 Uncompensated Risk
The main problem with focusing on dividend-paying stocks is that it often leads to individual stock investing. An investor choosing her own stocks is taking on uncompensated risk. Uncompensated risk is risk that can be diversified away. Said another way, if you can diversify a risk away, you will not be paid for it. Holding a portfolio of five or ten stocks involves taking a lot of single stock risk. Since this risk can be diversified away by simply purchasing a low-cost, broadly-diversified index fund, the investor is not compensated for it. Investing is all about risk control; there is no reason to run risks you are not paid for.
Choosing your own stocks also brings manager risk into the equation. Studies are very clear that even professionals with millions of dollars of resources at their fingertips cannot pick stocks well enough to reliably best index funds over the long run after paying the expenses of doing so, especially on an after-tax basis. If the professionals are unlikely to do it, an individual investor should have serious reservations about trying, especially after considering the value of her time.
# 2 Failure To Focus On Total Return
Another major issue with a dividend-focused investor is they often become so focused on the dividend, yield, or income of an investment that they fail to pay attention to the most important metric–the total return. One need only take the situation to the extreme to see the problem with this focus. Imagine two stocks. The first has a yield of 10% and the other has a yield of 0%. Which one should you invest in? While a 10% yield sounds more attractive than a 0% yield, the correct answer is “I don't know” because the yield, by itself, does not provide enough information. Broker-sold Real Estate Investment Trusts (REITs) are notorious for this. They promised an “8% yield” which seemed really great until the investors realized their shares were only worth $3 each instead of the $10 per share the investors originally paid. In reality, a significant chunk of the “yield” was more like a return of their principal. Total return is the return that matters.
# 3 Mistake Dividend Stocks For Bonds
An even larger error dividend-focused investors make is somehow assuming that because dividend stocks provide periodic income, that they are bond-like instruments. While dividends do have less volatility than share prices, they do still have plenty of volatility. Companies, even solid dividend-paying companies, do go bankrupt from time to time. WorldCom, Enron, Lehman Brothers, and Sears all paid a dividend at one time. Even venerable GE just cut their dividend to 1 cent per share. Stocks are still stocks, even if they pay a dividend. In 2008, not only did the price of shares drop dramatically but so did the dividends paid. Of the 500 stocks in the S&P 500, over 100 cut their dividends within the first six months of the crisis. Meanwhile, bonds maintained their yields and went UP in value. For example, the Vanguard Intermediate Treasury Fund was up 13.49% in 2008 while the Vanguard High Yield Dividend ETF was down 32.37%. Those two returns are obviously not even close to being equivalent.
# 4 Dividend Stocks Are Tax-Inefficient
While qualified dividends are taxed at a lower tax rate than ordinary income, distributing dividends at all isn't necessarily good for investors. This is the reason that Warren Buffett's Berkshire-Hathaway has never paid a dividend. If no dividends are distributed, the investor gets to decide when to pay the taxes on their share of the company's earnings. The investor can “declare her own dividend” any time she likes, simply by selling some shares. But in a year when no income is needed, none must be taken and no taxes need be paid. Deferring those taxes has real value given the time value of money, and thanks to the step-up in basis at death (or similar tax treatment through charitable donation of appreciated shares), might even eliminate the taxes completely.
# 5 Inefficient Method To Get A Value Tilt
British Columbia is a crazy place. Not as crazy as mistaking a dividend paying stock for a bond, but crazy nonetheless.
Dividend investors argue that paying out a regular dividend focuses company management on actually earning a profit for the investors. They feel dividends are more “real” than share price increases. They can even point to historical data that shows dividend-paying stocks have outperformed the overall stock market over time. However, what they may not realize is why this has occurred. The reason is that dividend-paying stocks are generally value stocks, and at least in the past, value stocks have had higher returns than the overall market.
Whether this outperformance is due to investor behavior or increased risk is not clear (probably a combination of both), but many investors “tilt” their portfolio toward value stocks in order to try to take advantage of it. When studied, it turns out that using a dividend focus is not the best way to achieve this tilt. Investors, at least in the past, have been better off tilting based on a Price to Book ratio. So even if an investor avoids uncompensated risk and manager risk by using a low-cost dividend stock index fund or ETF, she would likely be better off using a simple value index fund or ETF instead.
Dividend stocks need not be avoided completely. In fact, I essentially own all of the dividend-paying stocks in the world via total market index funds. However, these five arguments demonstrate well why building a portfolio composed entirely of a handful or two of high-yield stocks is a mistake that will be regretted by many investors.
What do you think? Are you a dividend investor? What do you think the role of investing in dividend stocks should be in a portfolio? Why or why not? Comment below!
#4 is a big one that is often overlooked, particularly by those of us who occupy the higher tax brackets.
Even at preferential qualified dividend tax rates, depending on income you could be looking at 15% or 20% + 3.8% NIIT + state income tax of 5% to 10% or more on those dividends.
I’m not in the 20% bracket, but I do pay the NIIT and nearly 10% in state income tax. It works out to nearly 30%. I invest in index funds and would rather avoid dividends. Even with the tax-efficient funds I own, the dividends from my brokerage account will cost me close to $10,000 in total tax this year.
I do own some Berkshire Hathaway stock — it’s the only individual stock I own, and I love the fact that it pays no dividend.
Cheers!
-PoF
I only invest in index funds and have no interest in a dividend stock only portfolio, but argument #4 is obviously only valid is taxable accounts. That is, easily mitigate by holding one’s high yield dividend funds or stocks in the tax deferred side.
Agreed.
I agree that investing purely in dividend stocks adds a layer of risk to your portfolio because of decreased diversification as well as tax drag if in a brokerage account.
I see why there is an appeal where you feel like you can potentially live off dividends in retirement without canabilizing your equities but there are several posts out there that show you come out ahead by selling shares when you need it rather than relying on dividends which can be unpredictable
I have been retired for almost 10 years, other than my bet on nuclear power utilities my dividends have been either stable or increasing. Sure others can be unreliable, but electric utilities are generally not in that category unless they are very poorly managed like say P G and E, which is totally mismanaged.
@Vulcan Alex – except for my losing bets, all my bets have been winners. 🙂
In my view every person and their circumstances are different. For me in retirement I have almost 100% dividend paying individual stocks. They are mostly utilities that unless someone destroys our electrical grid will continue to pay dividends. I selected them based on their historical good management, and I purchased them at the low point of the market. I would not advise people today to do what I did since these stocks are more expensive. I also don’t pay federal income tax because I don’t have that much income. I plan to never sell them, even some that had issues and reduced their dividends have recovered their value. As I said this strategy is not for many people.
Glad you’re happy with your strategy, but I confess it is hard for me to get excited about a strategy when someone following it has so little money that he doesn’t even have a tax bill from it, especially when that person actually recommends against the strategy for others!
I’m not sure it makes logical sense to hold a portfolio you wouldn’t buy today. Given your low income, you could probably change the portfolio without incurring any tax cost to doing so, no? In that case, holding it is the same as buying it.
I am one of those guys that have a large percentage of my nest egg in dividend paying stocks. While I do have some apprehension that I have all my eggs in one basket, I have comfort knowing that my stocks are mostly dividend aristocrats/ kings. I also have not passed up a year to add to my Roth which helps with my tax problem. I currently have a dividend income of $40,000+, I’m still 10 years away from retirement. Reinvesting all dividends is growing my income exponentially. This may not seem like a great deal of money to most, but most people will be trying to live off Social Security alone.
Kings like Enron, Worldcom, Sears, AMD, Hewlett Packard, J.C. Penney, Dell, Chesapeake Energy etc?
Stocks are aristocrats until they are not, but those who invest this way seem to conveniently forget about the ones that are no longer aristocrats. None of the original Dow stocks are still in the Dow.
THIS! Survivor Bias is often ignored when people look at Dividend Aristocrats, Dividend Champions, etc. You would have to go back 30 years in the data, see who the Aristocrats were then, calculate buying that portfolio, and then see where you would be today. And even then you would be facing the “past performance is no guarantee of future behavior” stuff. But you never see someone doing that calculation
I’m not one to let things ride. Most that you mentioned gave warning. Maybe Enron was a slap in the face for most, but if you read enough and watch the market, you get time to make a move(or not). KMI, OHI, these two were seen before the price dropped. If the payout ratio gets too high, sell it. Watch the earnings. Sure, companies have a bad quarter here and there. But too many in a row, move along.
So….if your crystal ball allows you to sell stocks before they drop, before they cut dividends etc. why aren’t you running a mutual fund again?
Wow. Very hostile host. There are always 2 sides of things., but coming after people with comments like that are because you can’t think of anything else.
I understand that most people have a hard time with stocks and it’s easier to go with mutual funds. I get it. That’s how I started. But as I grew older and wiser, I moved to individual stocks. Never quit learning.
Now, about my crystal ball. I never did say I was never caught on the short end, but understanding what is happening to your stocks is important.
Nothing hostile about it. It’s a serious question you should be asking yourself. If you’re wise enough to pick stocks that will outperform an index fund in the long run, why are you only managing your money? Wall Street will pay you millions to scale up and do exactly what you’ve been doing.
The notion of outperforming an index fund misses the point of investing in the firsts place. I for one don’t invest to outperform anything, index fund included. I invest to meet specific goals that require a projected amount of income over a projected period of time.
To that end, depending on individual savings rate, time horizon, current net worth, current and future expenses, etc., there may be multiple ways to invest that allow for those goals to be met.
For example, if I start out with $5 million, and need $100,000 now with expected inflation rate of 3% over the next 5 years, my investment vehicles could be simply to buy US treasuries, and live off the interest. On the other hand, if that income will be needed for 30 years, inflation will be more relevant and therefore other investment vehicles may have to be considered.
There are many good reasons to use index funds: Diversification, an antidote for ignorance, low costs, and tax efficiency are some of them. However, there are other reasons for some individuals to choose other vehicles of investing that allows them to meet their goals. Hopefully, these reasons don’t involve outperforming the index funds, per se, but rather to attain certain specific goals.
So if there were a method to invest that made it more likely that you would meet your goals at the same level or less risk, would you be interested? For most dividend-focused investors, there is a method. It involves index funds.
If not, it’s your life and your money. But the data is pretty clear and what is seen in the past data is likely to persist into the future.
I see the host here is very hostile about all things related to dividend stocks. Financial managers hate them because they realize that buying stocks and finding information to support your strategy and is easier to do today than ever before. Paying a financial advisor a fee to sell you holdings that are exclusive to their firm, over time, will rob you of 25-40% of your gains over time. There are firms like Seeking Alpha, Simply Safe Dividends, AAII, Market Edge, etc……. that can help you learn and invest in individual holdings and keep the thieves from stealing your money. Just saying.
Bizarre comment.
First of all, the “host” here owns all of the dividend stocks, so why would he be hostile to them? That’s just weird.
Second, the “host” here certainly isn’t a fan of paying a “financial advisor” a fee to sell you anything, much less crummy actively managed mutual funds. It’s fine to pay a fair price for unbiased advice but the “host” is definitely anti-getting advice from commissioned sales agents masquerading as financial advisors.
Firms/websites that encourage individual stock picking are doing their clients/readers a disservice as the data is quite clear that almost all investors would be better off with an index fund. If you want a tilt toward dividend paying stocks, use a low cost, broadly diversified index fund that invests in those stocks.
As investing has become more of a focus in my life, I have learned that the broader market is affected upward by around 30% of the holdings while the remaining tend to remain flat and negative. It seems that taking a portion of one’s retirement funds (inside a Roth for me) and trying to catch a larger grouping of that 30% is a relative risk worth taking assuming diversification of other retirement funds has already laid a bed of relative safety.
If you think you can consistently identify the best 30% of holdings, you should quit your day job and manage a fund for a living.
I’ll let you know how it goes!
Actually, check that…. You better keep in touch, I’m likely to forget about the “little people” I meet on the way up 😛
There are some good points here but some of the arguments are straw men. The article seems to suggest, without actually stating, that dividend-focused investors do not diversify. I’m sure some don’t but I don’t see the evidence that dividend investors tend to focus on five to ten individual stocks. What about those that invest in diversified dividend-focused funds. Personally, I own upwards of 30 dividend/distribution-generating investments. While I’m sure there are some dividend investors who lack a total return focus, referring to broker-sold nonpublic real estate investments is a poor example because it likely represents the least common mode of investment. More likely, dividend investors are investing in publicly-traded REITs. Compare the total return of VNQ to SPY over most time periods and you can see that this is a mostly false argument.
I’ve seen articles critical of dividend-focused investing, but they usually ignore the historical total returns of dividend-paying stocks and the proportion of those returns attributable to the dividend component. Detractors often say things like you’re investing just to be paid back you’re own money, as if the purpose of any business investment is never to get a continuous flow of cash from operations and to use that cash for living. This concept arises from the notion taught in business schools that corporations are perpetual life entities. This idea fuels the notion that the off-ramp for taking profits is capital gains. Much behavioral finance research shows that the average investor never achieves this as often when they face drawdowns on their investment value of 20%-25% they head for the hills. I know personally of several people who retired or went back to work because of such drawdowns. I didn’t come by my focus on dividend investment as a result of some cult-induced affliction . I made a significant enough amount of money(and a desire to early retire) and determined that I could so in a more stable fashion with a portfolio of growing dividends and other income-oriented investments with only a limited exposure to capital gains-only investments that expose retirees or near-retirees to greater “sequence-risk” (the problem created by the timing of bear markets and one’s retirement date that renders projected long-term total returns almost meaningless). IMHO
I just articulated similar ideas in a comment. I tend to use dividend paying stocks as part of an overall portfolio management strategy that focuses on income “brick by brick, build a wall of income from various sources that you can spend in the finite lifespan.
There’s a reason it doesn’t state that. Don’t read something into it that isn’t there. Some dividend focused investors don’t diversify, some do. The article addresses all of them.
Sequence of returns risk exists for dividends too, not just capital gains.
I think those who have a financial advisor and can’t buy/sell funds without making a phone call might prefer dividend stocks. Because then they can keep it simple and just spend the non-reinvested dividends that have kicked off to their settlement fund, and don’t have to worry about selling.
Note that I’m not advocating this.
Glad you wrote on this subject as I have recently purchased a few more dividend stocks and a little of the Fidelity High Dividend ETF and Vanguard High Dividend ETF. I am mostly an Index Fund investor but thought I would have an easier time spending dividends.
For psychological or financial reasons?
Psychological reasons. It seems a number of savers have a hard time switching from accumulating savings to spending savings.
I believe it’s a mistake to think of dividend stocks vs. index funds as all-or-nothing, mutually-exclusive strategies. It’s perfectly possible to use both (and others) as part of your overall portfolio management strategy that allows for further risks to be mitigated.
There are 2 uncompensated risks when using index funds: “sequence of return” and over-valuation of the components of the index. As a result, there tends to be very wide variations in returns of individual investors vs. those of the index. At least part of that is due to needing to sell when prices are lower. I tend to think of buying and selling stocks, index funds, etc. as a transaction between two counter parties. I would much rather be the counter party that is price-sensitive when I buy or sell, and enter into that transaction with someone who is much more time-sensitive (i.e. someone who has to sell regardless of price). Choosing dividend-paying stocks at the right price allows me reduce the risks of overvaluation.
For the component of the portfolio that includes dividend-paying stocks, changes of success improves markedly by, among other things:
1) Limiting yourself to high quality companies (defined by factors such as debt, credit rating, growth rate, etc.)
2) Purchasing each such high-quality company at a fair (or better) valuation; “Price is what you pay; Value is what you get”
3) Each stock should be no more than 3 % of the portfolio
4) Each Sector should be no more than 15% of the portfolio
5) Portfolio of individual stocks should be limited to 30-40 companies
Of course, the above process takes time and energy. It’s a very satisfying feeling to see the balance of one’s investments. But I would argue that it’s even more satisfying to see diversified income in the form of interest from bonds, dividends from stocks, rental payments from real estate, and distribution payments from MLP’s/partnerships, etc. In short, diversifying sources of income to me is as important as diversifying asset types. Then I don’t have to be a time-sensitive counter party. I have the luxury of being a price-sensitive one in all my buy-and-sell decisions.
Sequence of return risk is market risk–that isn’t uncompensated. And it exists just as much for a portfolio of individual dividend stocks as a dividend focused mutual fund as a total market fund.
“Overvaluation” suggests you know the true valuation and the market does not. I would submit the market is far better at estimating value than you are as an individual. Is it perfectly efficient? No, but it’s efficient enough that the right move is to assume efficiency in your decisions.
I agree it’s possible to use both as well. Just like it’s possible to invest half your money intelligently and burn the rest to stay warm. 🙂
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” –John D. Rockefeller
Warren Buffett has said that the best investment the average American(one that does not plan to spend a great deal of time evaluating the intrinsic value of stocks, and does not have knowledge of the industry) is best served by buying and holding an S&P500 Index Fund. I agree with this and keep about 90% of my portfolio in VOO.
**The Argument for Value Investing**
Warren Buffett, using many of the value investing principles of Benjamin Graham has outpreformed the market rather well in his time.
If you can buy shares of companies that have a decent profit margin, great business models that allow them to raise profits without loosing money to competitors(barriers to entry), and competent management teams, then you can buy shares in companies that are better long term holdings than many of the companies of the S&P500 that do not meet this criteria.
Additional risk is present, a smaller number of businesses(dividend paying or not) will be more volatile than the S&P. and as such due to greater potential tilt a greater potential for gain or loss exists. There are less stocks to average out gains or losses that may occur.
I consider some S&P500 index funds and ETFs great dividend buys as they are stable and tend to pay a dividend yield of about 2% since I checked. They are value buys in my opinion because the S&P500 is essentially the entire means of production of the United States of America.
**An Argument for Dividend Investing**
Why is gold not an investment according to Warren Buffett? “It generates no income, and is not a productive investment, your income only comes from finding another person willing to pay your more for it.”(Paraphrased)
In the past when someone invested money or labor into a company or venture for a “share*, what were they referring to? When you put your capital or labor into an exploration or mining effort in the past it was for a “share” of the take, a “piece of the action”.
Why would anyone pay to own a share of a business that gives them nothing to own it, except that maybe at some point in the future they may find another person that will fork over more cash for that share? If the company does share buybacks then that’s fine, since that’s essentially a simulated dividend.
If I offered a miner in the 1700s or 1800s a “share” in my prospecting that did not include a share of the actual profits, and with no gurantee of a buy back, but told him that the internal value of the book value of my mining operation would go up and that he could find another guy to pay more for that share someday, he might just stare at me like I had escaped from a sanitarium. The miner might ask, “you want me to give you labor without an actual share of the profit?”.
In the days of old it was considered that the purpose of a business was to make its owners money……..that is the natural order. A business that pays no dividend and engages in no buybacks is a violation of that natural order, it is a rogue business!
Aside from voting rights the shares that do not pay a dividend or get bought back have no value, except what people think they are worth. It renders them a non-productive asset. It makes owning them pointless, except as a gamble. An investment should not only be productive, but also produce income for the investor/owner.
I would never work on a ship sailing to the far flung oceans of the world without a share of the booty, nor would I invest in the ship without a share of the take. Similarly I would never buy an individual stock or share in a company if it did not offer regular buybacks or dividends. A business that does not give money back to its investors.
Price appreciation must be based on returns and utility for me to consider it valid. If a share offers no buyback, no dividend, then there is no productive utility(usefulness), save from voting to liquidate the company, and even then an individual shareholder would have a hard time extracting utility from said share. A share without a dividend or buyback opportunity might as well be a pile of tulips, the only way to make money from it is to find someone else that will pay you more to hold it.
**Putting Dividend and Value Investing into Perspective**
Personally I would consider anyone that invests in direct real estate to be a value investor, and a dividend investor, and an investor in individual shares. A property that is rented out for income is a business and its owner owns a 100% share of its profits. The owner gets a 100% dividend, less expenses or reinvestment. If index funds were the answer, and it were so impossible to beat the market, then the ideal answer would be to not own real estate and to own a REIT index fund and call it a day…….or just more of the S&P500.
I buy individual real estate properties with a keen eye for intrinsic value……If I did not believe that I could do this I would just cram the money into the S&P500 or cram it into VNQ(REIT Index fund). Both my real estate investments, and individual share purchases have as of yet beat the S&P500, but not by a whole lot, and I expect that RTM will eventually suck my advantage back down, but I am happy with my buy and hold investments.
Personally I keep about 85% of my money in the S&P500 and about 10% in cash, and 5% in select value investments. I expect that my ten percent slice, a buy and hold slice, will equal or outperform the index fund…….mostly because I pick companies I intend to hold forever, I pick solid businesses based on intrinsic value.
I only buy into businesses that pay me a dividend, or buyback their shares. The S&P500 currently pays a dividend, and some elements of it participate in share buybacks, so I am still very happy with owning it.
That Rockefeller quote is one of the saddest investing related quotes I’ve ever seen.
I find it interesting to see you quote Warren Buffett and then denigrate companies that don’t pay dividends.
“That Rockefeller quote is one of the saddest investing related quotes I’ve ever seen.”
Like Rockefeller or dislike him, his stance on dividends is interesting.
“I find it interesting to see you quote Warren Buffett and then denigrate companies that don’t pay dividends.”
That does not directly address my argument, my argument being that the way that you get real value from owning a “share” of a company is that you get a “share” of its profits, I include buybacks in that category.
Why would anyone pay for a “share” in something if they have no way to get money back out except find someone else to pay more for that share. Businesses exist to reap profits for their owners/investors, that is the order, that is the way.
Warren Buffett loves dividend paying stocks, his portfolio contains lots of them. His BRK company has even payed money to its shareholders in the form of buybacks.
Warren Buffett in one of his shareholder letters talks about why he doesn’t pay a dividend but applauds the dividend paying path that the companies in his portfolio follow, and expressed that he hoped that they continue on that path.
” Most companies pay consistent dividends, generally trying to increase them annually and cutting them very reluctantly. Our “Big Four” portfolio companies follow this sensible and understandable approach and, in certain cases, also repurchase shares quite aggressively.
We applaud their actions and hope they continue on their present paths. We like increased dividends, and we love repurchases at appropriate prices. ” –Warren Buffett(shareholder letter for BRK, cited in BI)
I will not invest in a company that offers no compensation to investors: it must either pay me a dividend or buy shares back. I prefer buybacks in taxable accounts, and love dividends in tax sheltered accounts.
I agree with your argument that the purpose of owning a company is to get your share of the profits of the company. I didn’t think that needed to be stated because it was so obvious. That has nothing to do with whether the company pays out profits as dividends or retains them and increases the value of the company though. You can declare your own dividend any time you like, and that’s actually a lot more tax efficient. Your stubbornness on this point will prevent you from owning many profitable companies.
WCI,
I don’t think of Sequence of Return risk as the same as Market risk.
Market risk is the possibility of prices going down (or up, if you are short). Even though it has an effect on your portfolio, you are merely a bystander, in the up and down movement of prices.
Sequence of Return risk is the possibility that your portfolio will decrease permanently as a result of having to withdraw some portion of your capital to be used for expenses (non-investment activity).
Market risk is the volatility, and SoR risk is the personal consequences of such volatility. It makes a world of difference in how a person should think about these 2 distinct issues depending on whether you are in the accumulation (buying) phase or distribution (selling) phase of one life.
I disagree that market risk only applies to volatility and not to permanent loss. All of those risks are included in market risk. Shallow and deep risk as Bernstein would say.
Sequence of returns risk just refers to market risk showing up at a very bad time for you personally.
Nice post, agree with all these reasons. When I buy an individual stock, I focus on company that have good concepts (that I can understand) and is likely to survive long-term and likely to beat average market return (total stock index). If a company runs out of idea on what to do with its profits (i.e. R&D or expansion) and send the money (dividend) back to investors for them to pay tax. That is not the company that worth uncompensated risks (#1 on the post) to me.
Please post a list of those companies “likely to beat average market return” over the next year.
You caught me! Picking an individual stock over s&p is just pure gambling. I have no crystal ball to see the future. My 10-12 individual stocks is about 10% of my portfolio, the rest is in index funds. I set up automatic investment at Vanguards that buys index fund monthly. When I saw Bank of America dropped from $100+ down to $7 during financial crisis, I bought it and hold it long term, now $25. Same as when NVDA dropped from $290 to $140 in December last year, I got it, now $186. I happened to be lucky that 9 of 10 stocks in my portfolio beat s&p except one, GE, I got it at $17 now less than $10. Once I buy a stock, I don’t plan to sell it. However, I never buy a stock because it pays dividend. I hate to pay 20%+3% tax.
Is that the most fun way for you to gamble? Those folks in Vegas seem to be having a lot of fun (except the ones at the slot machines, they look miserable.)
I always say that if you accumulate a large enough nest nest egg then the low dividend that a generalized index fund pays out should be enough for you to live on. Accumulate and compound.
I hope I can be one of your heirs if that’s your strategy. You are likely to die with dramatically more than you retired with.
When I look at dividend playing stocks vs the 4% rule I found that I would need 25% more net worth to generate the same income.
Or put another way I would have to work 25% more years if I wanted to live off of dividends vs using the 4% rule.
No thanks
I’m not sure about the 4% rule. Yes, it’s old school and has been around a very long time, but what happens when the Bear market comes during retirement? Your next egg drops and your 4% does too. With the dividend retirement, if you picked the correct stocks, your dividends keep rolling in. I guess that’s the key on both strategies. Picking ther right investments.
No, the 4% rule is based on initial portfolio value adjusted to inflation each year. If you use current portfolio value, you can get away with a higher number. 5-6% as I recall.
Exactly. There are real consequences.
Question: How do preferred stocks fit into this?
The individual stock risk is still there over an index fund but the taxation is much more favorable on preferred if I understand this correctly and to my eye the taxation is very much like a bond (corporate, not govt/muni). I know at least one physician who confuses bonds with preferred, but he just hands his money over for > 1% AUM fee so there’s that. At the taxation level, they are very similar but they certainly don’t offer the price surety / security of bonds.
Rick Ferri likes preferred stocks. Larry Swedroe doesn’t. Not sure I ever came up with my own opinion. I do know I don’t need to invest in them to reach my financial goals (because I already did.) No called strikes in investing. That’s one I let go right by.
Basically, it has some characteristics of stocks and some of bonds. Swedroe thinks the worst of both.
No opinion is pretty good in my opinion. I can understand the pros and cons but I’m not sure how they would fit into my asset allocation. Since they are neither exactly stocks or bonds, it seems to me that they make the portfolio unnecessarily complex.
Since each degree of complexity increases both the workload of management and the probability of error (I’m looking at you medical system) I can’t justify including them after investigating.
I just found your website and read this article. I think you are promoting fear. It all depends on the individual and their abilities. Most people are not cut out for hands on investing. Index funds are a perfect choice for them. Some people want to be more “Hands On”. If you can navigate through some research and want to put in the time you can get some good paying dividend stocks that are relatively safe. You MUST stay hands on. You can’t be afraid to make moves. Some people are half way in between like myself. I have index funds and I have dividend stocks AND I have stocks that don’t pay dividends but I see a good upside potential in those stocks.
You have to keep in mind the nature of mutual funds is to give control to someone else. In the case index funds the someone else is the market. One of the things you don’t get with mutual funds is the right to vote on proxies of companies. So now the funds control all of that.
If <10% of professional investors running pension plans and mutual funds and hedge funds can't pick stocks that will beat an index fund long-term, don't you think it's a little cocky to think you can do it between patients? Maybe you can, but if you can, you should be running billions not your own little six or seven figure portfolio.
But if you're willing to take lower returns in order to vote on proxies of companies, it's your money.
When you compare individual investors to Hedge Fund Managers and Mutual Fund managers, isn’t this not a fair comparison? I mean, the professional managers are managing large amounts of institutional money. Billions in many cases. These funds cannot say, buy a couple small microcaps that increase and have their Billions increase all that much. It’s too much money. They also would literally move the stock price. I think Warren Buffett even states he could do much better with less money. It’s actually an advantage when it comes to rate of return. Telling people to quit their day job to manage institutional money isn’t fair.
Also, I recently read that people who invest in Mutual Funds don’t have the patience to wait for the long run. A couple quarters of underperformance, and people pull their money out. Which I would think affects the performance of the fund. Hence, Mutual Funds managers can’t beat Indexes. Even Joel Greenblatt wrote about strategies which don’t work every year(Short Term) in The Little Book That Beats The Market.
That may be an issue for the very largest funds, but that’s it. I think it’s highly overblown as an advantage to be small. In general, a little more size provides economies of scale. You have to be pretty big to have real market impact costs-think Berkshire-Hathaway big. So I think it’s still a fair thing to say. If you can’t run billions, surely you could run $100M.
I agree that many/most investors have terrible investment discipline, but I suppose that applies in all methods of investment.
Great post. This is why I have been hesitant to invest in F (FORD) they offer a nice dividend but the stock has been under performing for years. Tesla has been struggling a lot lately but I still believe electric cars are the future. If Ford jumps into electric cars do you think the stock would do well or do you think it is one to avoid because of the dividend they pay out takes away from the companies bottom-line?
Did you read the post? Stop buying individual stocks and advertising penny stocks if you liked this post.
I’m all index funds. Never considered dividend stocks nor dividend funds. And after reading this article I’m more confident it’s something I can continue to ignore.
But this WCI thread caught my eye because I recently read a 2014 article by Dale Roberts who in 2018 still stands by it. I thought his article was interesting mostly because I have a brother that is like many posting here: has index funds & individual stocks & likes dividend stocks. So I was hoping to at least get him away from the individual stocks & maybe look at the dividend funds mentioned in Dale’s article, VWINX 33s:66b and VWELX 66s:33b.
I think Dale is talking more to retirees than to anyone else? https://seekingalpha.com/article/2560655-how-retirees-made-it-through-the-last-2-recessions
I love WCI and the Comments sections invariably help me beyond what I learn in the article. So any comments are appreciated.
I’m almost there! We do have an AUM advisor but this is for my wife’s peace of mind should anything happen to me (or my daughter’s POM should anything happen to US). The price of DIY would be an unhappy wife.
I do have MOST of my assets in index funds (both managed by our advisor and what I take care of). I do have 10%of our portfollio in P2P lending and CFRE (Realty Mogul, etc.) , and crytpo, gold, wine, etc. but again majority in index funds. getting VERY close to surrendering to your logic and at least putting my H.S.A. in index funds (currently in a 45 position high dividend portfolio of CEFs, MLPs, REITS, mREITS, BDCs, etc.) I can’t ignore your logic though … (I do also have an equal amount in self managed apartment buildings here in our town. Completely free and unleveraged now after 10 years of ownership) I have beaten the market a few years (3 out of 4), or rather, I’ve beaten a 60.40 benchmark, but I believe my risk adjusted return would be worse every year.
I’m interested to hear how you invest in wine.You mean there’s just a bunch of bottles in your cellar? Do you have special insurance on them?
Tons of data shows dividend stocks tend to outperform relative to non-dividend stocks.
http://csinvesting.org/wp-content/uploads/2012/06/high-dividends-research-by-tweedy-browne.pdf
Yup. It’s one way (although probably not the best way) to get a value tilt and value stocks have outperformed in the long run.