What You’re Getting Wrong About Dividend Investing
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Welcome to investing insights. I'm your host, ivana hampton. Does diving investing create bad investor behavior? This tragedy can split investors into two camps, those in favor and those against.

Here's hard works. A company will pay out part of its earnings to stock owners. Typically quarterly, those dividends can arrive as a checking the mail or cash in a broad account.

Critics say this isn't a bonus, but I cut into the total return, but income focus investors don't seem to mind. David hero is the editor of morning stars dividend investor news letter. We talked about the psychology of diverse welcome back to the forecast.

David. Thanks for back.

Let's start with why dividend investment has divided so many investors.

why i'm not sure the investors are divided. You know, as an editor of a divided oriented newsletter, certain going to hear from the investors that are very pro dividend investing um but I think if investors are divided or maybe sometimes confused, it's because they're getting mixed messages about dividends.

So if you read the you know sort of financial headlines, you you see the news like earlier this year, I think we spoke about I get some big name companies initiating dividends for the first time, metal platforms in alphabet. And in often cases, I that was praised as a good thing. You see headlines about dividend increases that's generally views as positive.

There's a whole idea of dividend growth investing by identifying companies that are growing their dividends at a regular pace. Uh that's indicative of companies with you know strong growing earning um so that's consider a positive. Um and there is also this idea that divided stocks can be defensive in recessionary periods.

So these are all sort of pro dividend messages. Uh, at the same time, you often see stories about how well dividends are inefficient way for companies to return cash to their shareholders and that maybe investors are irrational in pursuing a dividend focus strategy as opposed to a total return this strategy. So for those reasons for that reason, I kind of feel that um you know investors are divided, but sometimes they are getting two stories there or not. Maybe sure whats going on with dividends.

Good point. So talk about a couple of pitt falls that income focus investors should be aware. I mean, there's dividend policy.

What's going on there? okay. So the dividend policy um if if you're bearing with me, so we're only a couple weeks past halloween, so maybe you ve got some halloween Candy floating around your house still. okay.

So so let's let's say that you and I went to retreating and we have some those full size Candy bars left yeah so and and let's say that, mike, Candy bar, full size Candy bar, same issue represents a share of a one stocks share for a dividend paying company. You have the same Candy bar, but yours is going to represent a non dividend paying stock. Now the dividend falls.

Acy comes in a play where this idea that I have my chocolate bar and when I get my dividend is like an addition to my full size chocolate bar and getting them, those little mini chocolate bars, the bite size. So now i've got my full size and my bite size. You've only got your full size, so i've got more chocolate than you, so i'm Better off than you.

And what investors don't realize is that stock Prices do adjust for those dividends that are paid. So I might have a full size bar and a bite size, but my full size bar has shunk just a little bit. And I have the same amount chocolate before.

So you and I have the same amount of chocolate. But my false is that i've got a little piece that you don't have, so I have somehow have more so so the chAllenge here, of course, is that you know, stocks are in Candy bars. Stock Prices go up that go down.

So the Candy bars are always shrinking or growing, hopefully. So you might not realize IT that uh this divided payment has caused cause the little a shrinkage for you. Um but in fact, IT does.

And that really is the dividend policy that you're sort of getting the dividend payment on top of the capital gain uh and so that the dividing pain stocks were always be giving you more in total. And that's not necessarily the case. There's the different infancy also can um occur when people think about the defensive nature of dividends stocks.

So there is a case that dividend paying stocks are defensive because the types of stocks that pay dividends that tend to be a large cap, more value oring to companies, established firms, uh, from certain sectors. So when you have a broad market downturn, those sectors sometimes hold up a little Better. So there's a defensive component, the dividing stock. But I have sometimes here people say, while the dividend payment ams volatility and that sort of a second order dividend policy because, uh, the divided payment also did resolve in a change in the share Price. Uh, so it's it's fair to say that dividend stocks in certain recessionary environments can be defensive, uh, but the idea that the dividend payment is what's dampening volatility is is not correct.

And what about dividing trust? I mean, you can look too good to be true, but that's typically a warning signal, right?

We can be. So I mean, this is really the danger of of buying stocks based, you know on one meters or one number. So you're looking at the stock and you know the stock is yellow, three point five percent, and stock b yelling six percent.

You know, I go, well, i'm gonna buy stock beat must be a Better, a Better purchase and IT could be uh but sometimes, uh, there are what what you refer to as dividends traps. And this is a situation where if we think about how yield is calculated is a very simple calculation. It's the current dividend rate of the stock divided by the sheer Price.

Uh, but if that share Price starts to create to go down, uh, because the denominators getting smaller and smaller, the resulting yield is going to be higher and higher. So if you see a high yielding stock, IT could just be A A, A great company that's paying out a lot of its earnings as as a dividend. IT could be a good investment.

IT could also be a company that has uh, seen its its you sort of being pushed up by declining share Price. A declining share Price Price might represent some fundamental chAllenge to the company's business model and IT might even indicate that there is a dividing cut coming into the future. Uh, so buying on you have alone uh can be a dangerous uh, strategy. You know .

popular argument is that investors should be indifferent to a company's dividend policies. why?

So you know sort of think about, you know how you make money from stocks. So there's really two components here. One is the capital game.

So you you buy the share four hundred dollars IT goes up to two hundred dollars you have, then you can sell and you realize one hundred dollar again. You can also uh, receive dividends from the stock. And that obviously counts in your favorite part of your total return. The sort of argument that investors should be in different is not a new one. There was A A landmark paper on this thousand nine hundred and sixty one but really the idea is that investors should be focused on total return instead of uh dividends alone and that dividends, if you really need current income, you always have the option to create your own dividend by selling some of your shares um and that you can do so at the time of you're choosing where is dividends are coming quarterly, whether or not you want them um so so that's the right part of that is not the dividend policy but the idea that a dollars a dollar, whether IT comes from a dollar of dividends or IT comes from you realizing a dollar by selling a share or a portion of a share.

And you ve written a column morning started diving investment news later that supported a dividend focus investment strategy. You point out that a vectors could side step the safe withdraw right? Dilema talk about.

well, i'm not an experiment on withdraw rates. I'll leave that colleagues like Christine bs and such. I guess my point there was that, you know people often reference to the trend dy study, which shows that a four percent with raw rate is a safe withdraw rate for thirty year time period.

But then there's a lot of discussion about that is like, well, what if you have a forty year uh, retirement period, expected retirement, what is what is Price multiple are very high right now, all all sorts of things. And i'm not advocating this necessarily. As you know, this is beyond indal for A N investment strategy. But IT does side step sort of the issue of of making withdrawal that if you have a diversified portfolio of dividend stocks that providing a yield of, say, three point five or four percent, are you are essentially able to get that amount of income from the portfolio without having to make a cell decisions on an ongoing basis.

And imagine this earlier, the idea of creating your own dividend. Why do you think some folks may not find that is appealing?

I think it's there there's lot of psychology here and and one is that you know a you know you get the check in the mail or you get the dollar showing up in your broker statement with a dividend, uh, and it's sort of taken out of your hands. Uh, there's you know I have plenty of investment or such decision regret when IT comes to investing. Um so you do have that option of creating your own dividend at any time.

You can sell share, uh, you can sell fractions of shares now very, very easily with many brokerage platforms. So you always have this option to create income by selling shares of stocks that you own. Uh, but that sort of creates a whole other set of questions.

You know which shares do you sell from your portfolio? Then you have subsequent decision regret because, oh, I sold those shares and now those shares have gone up. And um i'm not suggesting any way that you settle for a sub table strategy or anything like that. But simply saying from a psychological standpoint, divided investors don't face those questions because they are receiving that regular income from their portfolio without having to um to sell to cell shares. And we've talked .

before about divide stocks verses the broader market. And one star has done research that shows why investors may want to think long term when comparing performance.

What do you say? Well, yes. Um it's I was recently looking at the Robert sholder numbers, which date back to the late uh eighteen hundreds. So we have a very long term record of U S. Large cap companies in terms of their earnings, how their earnings have grown and the dividends that they've paid out on a monthly basis is going back basically hundred and fifty years.

And if you look at the dividends as a portion of earnings, uh, we're in a different place today than we were you know, in the next point of the twenty century, for example, where companies are pain A A smaller portion. Of their earnings as dividends. And there's there's there's multiple factors here.

One is the rise of buybacks or share repurchases as a way of returning cash to shareholders. And it's also um that you know over the past ten, fifteen, twenty years, um you know sort of a lot of the market capitalization and U S. Equity returns have been driven uh by these mega cap growth companies, uh, tech and communication services firms but have opted not to pay dividends.

So you know you can slice and ice IT in many different ways. Uh I know there is some kind of french data. Uh, that morning stars indexes team cited in a study looking from the late twenty three, twenty twenty three and they found that higher yielding stocks actually had the best return uh and beat that over the broad market. I was looking at a shorter time period, uh, the twenty year period that ended in twenty twenty three and dividend stocks or dividend index is did slightly outperform the broad market.

If you look at rolling returns for the past thirty years, particularly the past you know, five or ten years, we see that the broad market has outperformed uh, A A divided focus portfolio or index and precisely because a lot of that market return has been driven uh you know by some of these these big name tech and communication services firms, uh, which until recently, many of them were not paying dividends. Uh, but as we spoke about before, you know, we now have uh meta platforms alphabet paying dividends. And I think if you look at the top ten companies by market capitalization right now, amazon 点 com might be the only hold out for paying a dividend。 Not keep in mind the the yellow of these companies is relatively low below one percent for you know um apple, microsoft um alphabet and not a platform. They're not typically onna show up in a dividend focus portfolio or uh an index. Uh but we are seeing you know, uh, more companies paying dividends at this point, at least relative to where we were even a year ago.

Our share purchases a Better way to .

turn capital stock owners. The well, the argument there is that, uh, sharing purchases are a more efficient way of returning cash to shareholder. So if you own a divided pain stock, a taxi ble account, uh, if it's a qualified dividend, the very least you're going to pay the capital against rate tax rate on on that dividend.

Um so even if you reinvest the share, reinvest your shares, you're going to have a tax bill for that with share we purchases where the company takes their cash instead of distributor as a dividend to shareholders. They instead by shares from the market, are they reduce their share count? And how this benefits the remaining shareholders is that now there are fewer shares to spread their sort of across.

Uh, so in theory, all being equal, in terms of are the Price multiple, you should see a corresponding increase in the share Price. So in that sense, as a shareholder, you benefit because now your shares are worth a little bit more, but there is no tax implication until you go to sell those shares. Uh, so that's why, uh, people say that buyback the purchases are more tax sufficient relative to dividends.

So let's turn the tables now. What are a couple of points that you can make against a divided focus investment strategy?

sure. why? I think you know the main one would be the one I mentioned earlier, where investors are attracted to companies based solely on the yield.

They're not looking at valuation h. They're not looking at you know potential earnings growth or anything else. They are just saying about five percent, six percent, you know you know let me buy that.

Um the second is that you could, uh, in pursuit of yellow, assemble a portfolio, uh, that doesn't capture some of the areas the market where where future returns might be greater, uh, that you're very light in some of the industries or sectors are going to provide the greatest total return going forward. Now what that is we don't know. Um so I I would say that sort of the main drawback.

Um and then if you are years away from retirement and you don't need the current income, there is the there is a tax inefficiency argument there. Um but I would you know back back away from that by saying that you know we we spend a lot of time, or at least perhaps I do too much time looking at what divided strategies doing relative to the broad market. And first of all, I have heard from you know subscribers in such that you like I I don't really care about the broad market.

I I am looking to find my retire and and I ve a growing stream of dividends and IT does that. I'm happy with that. So that's that's one point. But I think also is that we don't invest sort of in the abstract, you know the ideas, yes, you want to maximize your total return, uh, but the successive investor is based on several things in in one of these their behavior.

And um I I don't think we need to come down hard on one side or the other in that if pursuing a dividend focused investment strategy causes you to maximizes your savings and investment and get you to your goals and that's that's a perfect strategy for you. Um if a strategy that you are not focused on current income but rather total return, if that get you to your goals, um you know that's that's a great outcome as well. Um so I think we spend a lot of time in the abstract you know dividends did they are perform dividends, socks up, performer under perform the broad market uh and perhaps less attention to do investors behave in such a way because of the stocks that they want to purchase to, they behave in such a way that allows them to reach their financial goals. So I was gonna .

post this question to you, but I think you just answered IT because I started the show asking whether divided investment is created, bad investor behavior. But what say you I think .

IT occasionally does in individual purchases where people purchase for yield alone. Uh, but I wanna say that IT necessarily creates bad investor behavior. And then you know we are looking at historical time periods and you know in in a the vast majority of sort of the data that we have looking over the twenty years century, a dividends were a very large component of total return. We've seen less of that in recent years. Uh, but I went when I necessarily predict you know what we're going to see in the future. Uh, but I I think IT doesn't have to be uh an either or approach that investors who desire current income, who want the stability of of uh of a the cash of from a different import folio makes perfect sense for uh and that might you know be a great investment strategy for them uh in the if that doesn't appeal to they don't have to pursue a different strategy. But we can have we can have good outcomes in both with both uh, approaches.

So pic, what's gonna keep you motivated?

I think so. And I think that's the know one thing about dividends is that you know investors, you know the very active investing is you're foregoing current consumption uh, to fund some future goal, beat retirement, your children's college education, you know, whatever that might be. And it's sort of sometimes hard to stay motivated because it's something that's in ten, fifteen, twenty and thirty years down the line.

One thing about dividends is it's a very tangible. Sort this is tangible aspect to invest in. You start to receive an income stream and you can sort of match that come income stream to maybe some of your liabilities.

And i've seen you know on social media, like without my dividend, my month, my my monthly divided experiments, now they pay for my phone bill. Next month I am going to have enough. They are going to pay for my my car payment or something like that.

Uh, so it's causing you know positive investor behavior because they're motivated uh to to to increase that dividends stream for themselves. Ah so I think it's a very positive uh, aspect of dividends again, you know you can you could possibly do the same thing by creating your own dividend. Um but I don't think investors, uh, because it's less tangible, I don't think I don't see the same excitement uh from that from the create your own dividend uh that you do with some uh dividend enthusiasts. Well, David.

thank you for coming to the table and explaining the psychology behind divided.

Thanks for me .

that wraps up this weeks episode for listening and making this show part of your day. The investment insights team asked that you give our podcast five stars to help others find the work we're producing for you. Thanks to see your video producer check the Anderson and associate multi I media editor.

Just a bubble. Am I van a hampton? The multi I media edit and morning star take care.

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