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Is Dividend Investing a Bad Bet Because It Is So Popular?

Everywhere you look these days there are articles and news columns written about dividend investing.  Apparently simply looking at dividend stocks can transform anyone from a below average investor to someone that beats the market overnight.  Simply make sure that the stock has a history of raising its dividends, and then sit back and watch the money pour in.  The modern argument goes something along the lines of: The dividend payouts of today’s blue chip companies are higher than the return you’re going to get on 10-year bonds, so you’re crazy if you don’t

The Dragon’s Brood

The other item that constantly pops up in these discussions is the fact that if a company has a healthy dividend, that means it is a “mature” company that has a proven business model.  Kevin O’Leary of Dragon’s Den fame claims that his mom taught him this a long time ago.  Given all of this hoopla over the indestructibility of dividend stocks I bet his mutual funds are performing great… err… even average?  Nope.

Not a Bad Idea

Hey, I got nothing against dividend stocks.  I think looking at dividends helps people keep investments for the long-term and avoid destructive behaviour.  Any time you can do that for an investor, that’s 80% or more of the battle right there IMHO.  Because dividend stocks are usually blue chip companies, you likely won’t lose your shirt very often, and even in down markets you will have a nice stream of income to either enjoy, or re-invest in order to maximize returns.  I love the idea of dividend reinvestment plans, and compounding returns.  In short, there are a lot of a good things to point to if you want to be an authority on dividend investing, the only problem is that if this were a model that actually beat the market, it wouldn’t beat the market anymore.

Reverting to the Mean

Investment companies have NASA mathematicians and MIT honors students to invent models for them to generate market-beating performance.  They are also constantly on the lookout to steal any idea another person has and implement it themselves.  You know what the end result of that high pressure world is?  A stock market where no model (no matter how complicated) beats the market for very long.  So, either dividend investing is the one magical model that always beats the markets and must basically fly under the radar of the NASA and MIT guys, or it is probably just a very good, pretty safe, way to invest your capital.

Contrarian Bias

As someone who knows he isn’t as smart as the boys over at NASA, I’m a committed indexer for life.  After reading Andrew Hallam’s book, and seeing a guy that bright and committed not being able to outdo the market with dividends or value-concentrated strategies, even when part of an investment group of really smart people I’m more convinced than ever.  I think that the smartest people out there, the Warren Buffett’s and the really shrewd value-based investors (who are usually “contrarian investors” by definition since that’s almost always where the value is) are probably getting out of dividend stocks right now.  A great general rule that I see repeated over and over again by the smartest people in the business is that if everyone in the media is recommending a strategy, then it is probably very profitable to do the opposite.  Small caps anyone?

Comments

  1. Echo

    Do you have any data to back up the claim that dividend investing is so popular? I mean, other than a few bloggers touting the benefits of investing in dividend stocks? I hear more people talking about Facebook and Apple (granted, they pay a dividend now).

    According to Tom Connolly, the average cost of a dollar’s worth of dividends from Connolly Report list as of November 1 2012 is $25.65. The average since 2000 is $33.67; in contrast, on March 7 2009, it was $16.46.

    So, while we’re not seeing double digit yields like in ’09, it’s not like most dividend stocks are crazy over-valued right now.

    I think the point of any investing strategy, whether it’s indexing or dividend investing, is to stick with it for the long term and not jump to the latest fad.

    For the record, I bought most of my dividend stocks in May 2009 and probably add to it 2-3 times a year.

    • Kyle Prevost

      Definitely too lazy to look up small cap vs large cap/dividend numbers Echo. Besides, I don’t think I’m smart enough to do a comprehensive review. My opinion is solely based on the major uptick in mainstream media recommendations I’ve noticed, and it has been pretty substantial.

      • The Passive Income Earner

        @ Kyle
        I was going to comment the same as Echo – I don’t think it’s popular that much. My co-workers would probably ask what is a dividend? but they would know what Mutual Funds are.

        Magazines and newspaper definitely discuss it but I don’t think it actually represents a proportion of money going into the markets.

        • Kyle Prevost

          It’s very doubtful your co-workers would truly know what a mutual fund is either. They would know what a salesman had told them was a mutual fund, and there is an appreciable difference there. I guess the comment would have been better prefaced with something like, “Growing popularity amongst retail investors.”

  2. My Own Advisor

    You’d knew I comment here, on this one 🙂

    Dividend investing makes sense because you’re essentially taking more birds in the hand than waiting for those in the bush.

    In the end, total returns matter. So, investors can either choose to take some risk in the form of individuals stocks with higher yields up front, or defer gains as part of capital appreciation in the indexes.

    Both strategies work, you simply take much more risk with dividend investing because of less diversification, assuming your holding periods are the same to adjust for inflation.

    I would suggest dividend investing is less popular than most other forms of investing. I’d argue 50% of Canadians wouldn’t know what dividend investing is.

    Mark

    • TM @ My University Money

      Mark, out of people who actually pick their own stocks, what percentage would you say are more aware of dividends now vs any other point in recent history? All you read about are people touting dividend stocks that have higher dividend ratios than 10 year bond rates. I would say way less than 50% of Canadians know what dividend investing is, but I would also argue less than 10% of Canadians have any idea about how to valuate a stock or much else concerning investing.

  3. Glenn Cooke

    I’m not a fan of dividend investing simply because I did my research and concluded that index investing provides higher returns than anything else – including dividend investing.

    However, dividend investing has potentially better tax advantages than other investment strategies. I wonder if anyone’s done the research to determine if the tax advantages of dividend investing outweigh the potentially lower rate of return over the long term.

    • Kyle Prevost

      Agree with both points Glenn. If I ever max out my tax-advantaged accounts I would look at dividend strategies for my non-registered accounts. I’m far from that stage at this point though!

  4. Brian

    My small cap mutual fund is my best performer, lol. I think dividend investing is a good part of a long term investment strategy. This income forms part of our retirement plan, given the steady stream of income. I also like index investing and will be moving most of my RRSP mutual funds to index based ETFs in the next 3-6 months.

    • Kyle Prevost

      Dividends a great… and so are capital gains. As long as it’s return on investment I couldn’t care less what they call it.

  5. Cherleen @ My Personal Finance Journey

    I never realized that there is a bad investment. As far as I am concerned, it will always be a good investment as long as I get a steady income from these investments. Looking through my portfolio of investments, I think I am on the right track.

    • Kyle Prevost

      See this is my exact point Cherleen. No offence, but this comment clearly shows why dividend stocks may be overvalued right now relative to small-cap stocks that are much less well understood. The only thing that really matters is the overall return on investment if all things are equal inside of a registered account (much like Mark pointed out).

  6. The Passive Income Earner

    One part of your post mentions beating the market and for me, dividend investing is not about beating the markets at all. If the dividends provide me with the income and growth I want, then I am good.

    I showed a graph on my blog where my income is continuously growing whereas the markets are fluctuating. That’s much more important to me to have consistent income growth than comparing the overall value to an index.

    I want to be in a position where my investments generate the retirement income I need without dipping into the principal. If you plan to withdraw from the principal than you are impacted by the ups and down of the markets – how many people got hit badly in 2008? How many cut their dividends? Regardless of the value, when the dividends remained, you had the same income regardless of the markets.

    On a side note, Andrew made his money by picking stocks 🙂 He was good at it. I don’t believe he would have grown his portfolio as much if he had indexed from the beginning. His land purchase would not have gained as much in such short time either. I am not sure if he modeled that. Don’t get me wrong, indexing is a good strategy but I don’t do dividend investing to compare myself to an index 🙂 The irony is that I have more than 50% in indexing through my defined contribution plan and I much prefer the performance of my dividend portfolio.

    • Kyle Prevost

      PIE, a taste for indexing vs dividend strategies is likely somewhat reliant on your investment time frame as well. As a young guy who is not looking to take income from his investments anytime in at least the next twenty years (and probably more like 30), overall ROI is more important to me than generating money tomorrow. Why eliminate a whole class of stocks like small caps that have historically provided higher overall rates of return?

      I guess I should let Andrew speak for himself, but from what I’ve read of his investing adventures he talks about his time as a “value” investor, having an investment club with other smart people, and still not being able to beat the index. That is all of the proof I need.

  7. FullyInformed

    Great article but something is missing for a lot of dividend investors and it’s risk management. Many people look at dividend stocks for their dividend only and/or their ability to grow that dividend. But earning $1.00 dividend on a $28 stock and then watching the stock collapse to $19.00 or lower is never fun. ETF’s are often much the same. Instead in my “couch potato” portfolio of dividend stocks I buy dividend stocks during periods of high volatility such as the fall of 08 or spring of 09 or May 2010 or August 2011. Then when volatility subsides I sell covered calls at a variety of call strikes. Some stock gets exercised away and other don’t. This builds back my cash base for the next period of high volatility and earns substantial returns in double digit territory. This has been my strategy since the 1980’s on dividend paying stocks. In a retirement account it works wonders since there are no taxes and I use a discount broker. An ETF may seem safer but in times of volatility everything falls as do ETFs. Sometimes thinking a little outside the box is all that is needed. Thanks for a great article.
    Teddi Knight

  8. Canadian Couch Potato

    Great discussion. I don’t have any data to back this up, but I do think dividend investing is much more popular now than it was 10 or 15 years ago. A big part of the reason is that dividend stocks (especially in Canada) have done extremely well in recent years. In the 1990s and in the mid-2000s, when growth was extremely strong, dividend investing was sometimes seen as stodgy and overly conservative.

    The one thing I have noticed (and I’m not sure whether this has always been true) is that many people simply take for granted that a buy-and-hold dividend strategy will lead to market-beating returns. For example, the current issue of Canadian Money Saver includes a book review that states: “A dividend investing style is likely to do better than the overall market index.” That is an enormous claim, yet the writer offers nothing to back it up.

    In the end, a well diversified dividend portfolio with minimal turnover is likely to deliver very similar returns to the overall market over the long term. As Boomer said, the real key is whether you are prepared to stick to the strategy. Inevitably there will come a period of several years were dividend stocks underperform. Those who hold on will do just fine, but I imagine some of the less committed will lose faith.

    • The Passive Income Earner

      I totally agree with your comment about sticking to a strategy and holding on in good and bad. The flip flopping probably does more damages than anything else.

    • Simply Rich Life

      That writer touting dividend investing probably made a common mistake like comparing the total returns of dividend stocks to the increase in the index level with dividends excluded. Which would be quite ironic in this case.

    • Jiminy

      I don’t try to beat the market. I just want safe investments that give me a reasonable return

      For me, that means dividend stocks, REIT ETFs, and various dividend ETFs with low turnover that cover the world.

      I’ve done well so far using this strategy.

  9. Mike Holman

    I agree that dividend investing has gained in popularity in the last few years. Which is not to say that is has gone mainstream.

    I think one of the reasons was Derek Foster – his first book sold a lot of copies and really made dividend stocks sound like a dream.

    • Kyle Prevost

      Interesting, I wouldn’t have thought Foster sold THAT many books. That actually begs another interesting question. Would DRIPs sort of skew dividend stocks higher because they buy no matter what?! Hmm…

      • Jiminy

        No, I don’t think he sold that many. I think it was really only popular in Canada, and how many people are there in Canada buying investment books?

  10. Echo
    • Kyle Prevost

      All this guy did was take my basic argument and add tons of scientific reasoning and several interesting facts. I should still get some credit for generating the basic framework though right 😉

  11. Jiminy

    There has always been people who trumpeted dividend investing, and I think that in May 2013 there are more people swinging over to dividends, but I think many of these people are going to go back to bonds if the interest rate goes back up. Some are going to go to whatever they think is in favour.

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