Dividend Stocks: Any benefit beyond the psychological?

[PhysicianOnFIRE]

There is no shortage of investors and bloggers who focus on buying dividend paying stocks to create an income stream to help meet spending needs.

I understand the psychological / behavioral benefit from seeing those dividend deposits, but I'm also well aware of the downside of dividends in a taxable account. Namely, the tax drag from the dividends, which are essentially forced withdrawals from those stocks.

Larry Swedroe recently published a couple articles that make good sense to me.

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  Swedroe: Vanguard Debunks Dividend Myth

  
  


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  Swedroe: Dividend Strategies Fall Short

  
  

He is obviously a total return investor, too.

I'm interested in hearing any counterpoints. I'll be writing an article on the topic soon and it will be sure to attract some hate from the dividend investors. I don't know if there's another topic in personal finance that gets people more riled up. The defense of a dividend strategy in the face of evidence against it is fascinating, and I want to be sure I'm not missing something.

So... do you buy stocks or funds specifically for the dividends? Why?

[Donnie]

Dividend paying stocks are part of a diversified portfolio as far as I am concerned, and that's it.  I have seen no evidence that heavily weighting a portfolio to dividend paying stocks reduces risk or increases return.  Admittedly I haven't looked that hard or done any real research myself, so would be interested in seeing such data as I wrote in another thread on a similar topic.

I don't understand why there would be any debate on this topic or most in personal finance.  Unless there is data to support some benefit, there isn't a benefit that can be exploited.  We can all talk about our feelings on various topics I suppose, but that isn't particularly interesting to me.

[Hatton]

I will read the Swedroe links later today hopefully.  I have never really been an advocate for investing for dividends only. I think one needs to be very careful about buying a stock because it pays a big dividend.  Some of these deep value plays will bankrupt at some point.  The same is true for junk bonds.  I had an aha moment a few years ago when I realized that my portfolio would pay me enough in dividends and interest to live on (Mainly indexes and muni bonds).  It takes a sizable portfolio and a relatively frugal lifestyle to say this.  So maybe by default I am a dividend investor.

[StarTrekDoc]

Good read and opinion on the analysis POF. It's interesting in large swaths of recent recession times that regular 500 outperforms and vice versa.

The trouble remains as people mention, it's hard to time the top and bottom where the short term Delta can make a dramatic difference.

So in the strain of long term hold strategies, is there a place for these and bond holders too in general? I think so.

Like TE bonds, there is a constant stream of income. It's not pretty in boom times, but it is stable and reliable income production. Likewise dividend stocks pay out reliably and consistently, even during corrections and recessions.

https://www.forbes.com/sites/michaelfoster/2017/01/11/5-funds-that-crush-the-sp-500-and-pay-9-3-dividends/

This supports the thought the dividend stocks may help those believing that a correction is immenent but may not want to go full on bonds or cash instruments-- they want to hedge a little but stay in the equities market.

Those nearing retirement and especially -re maybe a bit more sensitive at the edges and want a reliable stream that's giving out.

[PhysicianOnFIRE]

Donnie wrote:

I don’t understand why there would be any debate on this topic or most in personal finance.

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I agree, but anytime data is presented that argues against dividends, the dividend investors get all riled up. See comments from snarlyjack in this Bogleheads thread. I see similar comments on various blogs from pro-dividend investors.

I suppose if you are in the 15% federal income tax bracket, expect to remain in that low bracket indefinitely, and are confident the tax code won't change to start taxing dividends again in that low tax bracket, then dividend investing is a wash when compared to index fund investing. That's as generous as I can be.

[VagabondMD]

I do not advocate focusing on dividend stocks, per se. Stocks that have track record of dividend growth tend to have above average loading of the quality factor, which correlates with higher long term returns.

For the reason above, I have a slice of my large cap US allocation in the Vanguard Dividend Appreciation Fund (VDAIX), though admittedly not enough to make much of a difference.

[CM]

PhysicianOnFIRE wrote:

I suppose if you are in the 15% federal income tax bracket, expect to remain in that low bracket indefinitely, and are confident the tax code won’t change to start taxing dividends again in that low tax bracket, then dividend investing is a wash when compared to index fund investing. That’s as generous as I can be.

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There is more to it than that.

I didn't search for the references again today, but I'm fairly sure that the data shows dividend payers have provided higher returns (than non-payers) over the long-term. As I recall, this association is not significant once one controls for other indicators of a value tilt. Nevertheless, the average investor who thinks dividend payers provide an advantage is not wrong (assuming I remember correctly that they provide higher long-term returns).

 

More importantly, dividends mitigate the agency problem for outside, passive, minority investors (OPMI).

If I controlled a company I would only declare a dividend when I needed the money. As an OPMI, I depend on the company managers to deploy capital in my best interest. However, the managers will always do what is in their best interest, not mine. I can only hope that there is significant overlap.

In most cases, the managers benefit by using resources to expand their empire with acquisitions (even at inflated prices) or to buy back shares to boost the value of stock options (even if the shares are overvalued) or just by holding cash.

When a company is committed to a dividend policy it imposes discipline on managers, and companies are loathe to commit to dividends unless they are very confident about prospects. Thus dividends are a signaling mechanism; one which is much more reliable than management pronouncements.

For these reasons, a commitment to dividends lowers my required rate of return when I evaluate an investment.

 

For data about the difference between theory and practice regarding dividends, see this Arnott and Asness paper from the Financial Analysts Journal: https://www.researchaffiliates.com/documents/FAJ_Jan_Feb_2003_Surprise_Higher_Dividends_Higher_ Earnings_Growth.pdf.

In a perfect world (imagined by business school professors) of highly competent and virtuous managers, lower dividends (higher retained earnings) should lead to higher earnings growth. Yet Arnott and Asness found the opposite effect.

[CM]

Vagabond MD wrote:

Stocks that have track record of dividend growth tend to have above average loading of the quality factor, which correlates with higher long term returns.

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I thought it was value (see my post above), but maybe it was quality instead. That would also make intuitive sense. Or perhaps both factors are associated. No time to find references now though.

[jfoxcpacfp]

You can probably guess where I stand, but I'll say so, anyway. I am dividend-agnostic. If dividend-paying equities make up a disproportionate part of your portfolio, it should be because that particular portfolio combination has the best opportunity for optimal long-term returns. After all, dividends aren't guaranteed.

I believe the reason many people like dividend-paying equities has nothing to do with any sort of complex theory. Receiving cash in the form of a dividend payout is emotional gratification. Just as some people like to keep a large bank balance, whether or not it makes sense to their overall plan. It's just "nice" to look at that those zeroes, same as it "feels" good to get that dividend check. That's why articles such as the ones you posted will have no sway on the feelings of the dividend crowd. Money gives them a sense of security free from the wet blanket of perspective.

Emotions and money are always a combustible combination.

[Dicast]

I think dividend stocks make the whole idea of owning part of a company more tangible. If I owned my own business I would expect it to produce me some income. I wouldn't want to sell part of my business each year to produce income. Owning a company that never pays a dividend makes it hard to feel that any real value is being transferred back to you as the owner. Of course the stock price should reflect the payment or non-payment of dividends but having to sell part of your ownership to gain any income has always seemed backwards to me.

I don't own any specific dividend oriented mutual funds or stocks. I have fought off my psychological bias to dividend stocks so far. I can definitely see the appeal and know more than one colleague that chooses to go dividend heavy.

[Zaphod]

85% of companies in the S&P pay dividends, its very hardly different than the whole market itself. Yes, past data showed dividend aristocrats out performed the broad market long term. However, everyone knows this now and the reason they did is gone (they were cheap, now very expensive).

I would bet the no div/growth biggies will and likely have been beating the div/arist the last several years and going forward.

Say an amazon, apple/msft, visa, fb, etc....will outperform xom/cvx/pg.

[Hatton]

I think the popularity of dividend investing hinges on favorable tax treatment.  As long as you can pay no tax on the dividend income this will continue to be the cornerstone of FIRE strategies and hence the internet comments.

[jfoxcpacfp]

hatton1 wrote:

I think the popularity of dividend investing hinges on favorable tax treatment.  As long as you can pay no tax on the dividend income this will continue to be the cornerstone of FIRE strategies and hence the internet comments.

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To clarify, tax treatment for qualified* dividends is the same as for long-term capital gains, as follows:

•  0% tax through the 15% bracket,


• 15% tax for the 25% through the 35% brackets, and


• 20% tax for the 39.6% bracket

*To be recognized as a qualified dividend, the IRS requires that you hold the stock associated with the dividend for more than 60 days during the 121-day period that begins 60 days prior to the ex-dividend date, or the day after a corporation's board declares a dividend payment to shareholders.

Non-qualified dividends are taxed at ordinary income rates.

[ReFinDoc]

If your $100 Stock pays a 2% dividend, you now have  $2, a Stock worth $98 and a taxable event.

Whats so hard to figure?

[Zaphod]

ReFinDoc wrote:

If your $100 Stock pays a 2% dividend, you now have  $2, a Stock worth $98 and a taxable event.

Whats so hard to figure?

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I dont know, people are somewhat ideological into it, so its generally not worthwhile as they are a bit irrational about the process. Its also an inefficient process from the company standpoint, which is probably why its become less common over the decades.