💸 Dividends - Do or Don’t Do?
⚠️ Not Investment Advice, just discussion.
In this thought piece, I want to explore dividend-focused or dividend growth investing as the investment vehicle of choice. I wish to put it in the context of the Who, When and Why. I will reference macro impacts such as Demographics and economic conditions. Also I will explore strategies that may offer an alternative/substitute.
IMO, three major types of investors may prefer a dividend-focused/growth portfolio:
1️⃣ Income seeking - Person requires regular income with some capital growth. Primarily for people who are approaching or are in retirement or in need of supplementary income. A full-time adult worker would have sufficient income and time till retirement. Would they focus on dividend investing as the preferred means of growing wealth?
2️⃣ Conservative - risk averse investors seeking lower volatility or more stable investments. This cohort of investors will have significant overlap with Income seeking investors. In times of uncertainty, a different cohort of investors may also allocate to this strategy in the short-term as a shelter from higher risk plays. (Quality) dividend stocks should be less volatile and experience lower drawdowns due to the more conservative nature of the firm’s management. Is this the preferred vehicle for risk averse investors?
3️⃣ Superior returns - this cohort of investors believe that this strategy will outperform over the long-term.
Typically, the argument is as follows:
From year 0 to year X, SPX equity index returned 0%, however, with dividends reinvested, the return was 20%. Therefore dividend investing is superior.
❌ This comparison is wrong! They are comparing apples with oranges.
The 20% return achieved is referring to the S&P500 Total Return (TR). This includes the return achieved by re-investing 100% of the dividends + return from price appreciation. In our example, the dividends after compounding returned 20%. The price appreciation was 0%. TR = 20%.
What they are comparing against is the S&P500 Price Index Return (PR). This is the widely quoted value we are familiar with e.g $SPX500, $SPY). PR does NOT include dividends in its calculation, it’s purely the price difference between two dates. In our example, the Price index returned 0%.
💯 Clearly, the Total Return figure cannot be compared to the Price Return only figure. TR incorporates dividend returns, the other does not.
In reality, if you invested in the S&P500 Equity ETF (SPY), you would also receive the dividends. The dividends received can then be re-invested. Your TR = SPY price appreciation + reinvested dividends less some frictional costs as transaction fees, tax, timing.
Therefore a comparison of SPX500 TR vs SPX Price Index Returns only show the difference caused by the compounding effect of dividends overtime. It implies nothing about out performance.
A comparison between say S&P500 TR Index Vs QQQ is probably more relevant. QQQ are tech or broadly high growth stocks. Although QQQ does pay a dividend, let’s assume it is small and we exclude it’s effect (we shouldn’t really as the dividends are also compounded and therefore over time does make a huge difference) to the QQQ Total Returns. In any case, if we compare back to the start of the bull market in 2009, clearly QQQ (price only) outperforms but with higher volatility. That’s what we should expect. Higher risk = Higher potential return (loss). See chart below.
If we select the the Dividend Aristocrats ETF, these are the creme-de-la-creme of companies that consistently grow dividends and often picked by dividend-growth investors. The dividend yield is 3%+ pa. The Total Return performance is less than compelling over the long-term (You'll note that I'm comparing to SPX TR not SPX PR). However, you do see the protective nature in bearish periods. See chart below.
A skilled stock picker no matter if he/she is a value, growth, dividend-focused investor should be able to outperform their relative benchmarks. There is value in being able to decipher who are the top dividend-focused PIs. However, the less convincing argument is that passive income through dividend investing is the optimal investment style over the long-term. The exception may rest with Income Seeking or Conservative Investors. Even then, for these investors, there are alternatives.
In the Part II discussion, I will look at the interest rate environment, demographics and much more to delve into its impact on Dividend focused investing in the future. I will also look at portfolio construction that might be useful for income seeking or conservative investors.
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