Author Topic: Question re: Vanguard mutual fund dividend payments  (Read 12992 times)

Wendyimhome

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Question re: Vanguard mutual fund dividend payments
« on: March 17, 2013, 06:25:09 PM »
I've held Vanguard mutual funds for years and, like folks here, I am a big believer and fan of them.  That said, the way Vanguard handles dividend payments on its stock mutual funds makes no sense to me.  (Other mutual fund companies probably do it this way as well, so I probably should not jump on Vanguard specifically about this.)

Anyway, here's the problem: Vanguard periodically pays out dividends that it has received on the stocks held by a mutual fund.  However, whenever it does this on a stock fund, it reduces the share price of that mutual fund by the same amount.  They call it an "X-Dividend."  As an example, if you receive a .41 dividend per share of Windsor II, you will see the share price of Windsor II drop by that amount the same day it is paid.  Can someone explain the fairness of that to me, please?  It sounds like robbing Peter to pay Paul to me.  What good is a dividend if it reduces the share price by the same amount?

Freestyler

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #1 on: March 17, 2013, 06:35:07 PM »
It is my understanding thatīs the way it is for any security. If there`s a payout in the form of a dividend the price of the stock goes down by that same value. Itīs normal as the value of the security that you hold decreases by the same amount of that payment. This and the fact that dividends are taxable (at least in Spain) make that I donīt like them very much myself.

KingCoin

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #2 on: March 17, 2013, 06:35:43 PM »
This is true of all funds and individual stocks and it makes perfect sense.

Imagine your fund is worth $100. It has $99 worth of equity and $1 of dividend that it was recently paid. If it hands you the $1, now the fund is just $99 in equity.

You may ask, why does a stock or fund XYZ that pays out $1 in dividends drop the same day it is paid out? Simple. People are rational actors. They know that stock or fund XYZ is about to pay $1 in dividends, so they factor that into the price of the stock. If people didn't factor this in, becoming extremely rich would be simple. You'd just buy stocks the day before they issue a dividend, and sell them the day after.
« Last Edit: March 17, 2013, 06:43:49 PM by KingCoin »

KingCoin

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #3 on: March 17, 2013, 06:43:20 PM »
I'll add that you're not really getting robbed. Imagine a fund that pays a $1 dividend on the last day of every month (for the sake of simplicity, assume that this fund is also immune from general market movements). You pay $100 for the fund on Jan 1. On Jan 31, the price will be about $101, will pay you $1, and drop back to $100, "robbing Peter to pay Paul". Repeat 11 more time.

On Jan 1 of the next year, your fund will still be $100, but you'll also have $12 in your pocket. So despite all those $1 "jumps" down, you've still made a 12% return.


Wendyimhome

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #4 on: March 17, 2013, 08:03:54 PM »
Is it that way with individual stocks?  I've never studied it closely, but I've not known stock prices to fall the day they pay out dividends...

KingCoin

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #5 on: March 17, 2013, 08:41:23 PM »
Is it that way with individual stocks?  I've never studied it closely, but I've not known stock prices to fall the day they pay out dividends...

Yes. Stock prices absolutely fall the day they go ex-dividend, all other things being equal. The fall is often hidden in the noise of the market though. For instance, if a $25 stock pays out a $0.10 dividend, but the company's value rose by $0.15/share that day, the stock will have gained $0.05 on the ex-dividend day. Conversely, if the company's value fell by $0.15/share that day, the stock will have lost $0.25/share.

Again, if they didn't fall, it would be a simple matter to constantly move your money to a stock that's just about to pay a dividend. If you moved your money every trading day to a stock paying out 1%, and it would be an easy 250% yearly return. Unfortunately, things aren't that easy.

skyrefuge

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #6 on: March 18, 2013, 09:03:20 AM »
As an example, if you receive a .41 dividend per share of Windsor II, you will see the share price of Windsor II drop by that amount the same day it is paid.  Can someone explain the fairness of that to me, please?  It sounds like robbing Peter to pay Paul to me.  What good is a dividend if it reduces the share price by the same amount?

Congratulations! On your own, you've discovered a key piece of information related to dividends that I think even a lot of Dividend Fetishists are unaware of: a company giving you a cash dividend has exactly the same effect* as if you had generated the same amount of cash yourself by selling shares. Both reduce the value of your remaining holdings in the company by the amount of cash you now hold. So despite how it is frequently portrayed, there is no magic free money "thrown off" by dividend paying stocks.

In what remains the most embarrassing episode in MMM history, the guest-poster brought in as dividend expert(!!!) was utterly unaware of this key fact (and as far as I can tell, still doesn't believe it).

* while the effects on your remaining holdings are the same whether a company pays you a dividend or you sell shares, the effects on your overall wealth are not, because in the case of the dividend-paying company, they force you to pay taxes on that income, on their schedule. With non-dividend-paying stock, you can choose when you want to receive income, and then you have the ability to defer taxes or pay potentially-lower capital gains rates.
« Last Edit: March 18, 2013, 09:05:11 AM by skyrefuge »

GreenGuava

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #7 on: March 18, 2013, 11:06:50 AM »
Others have hit the key points, so I'll add just one other thing:  if you're in taxable investing (it makes no difference in tax-advantaged accounts), don't buy the fund right before a dividend -- not only do you just get some of your money back in the form of the dividend, you also pay tax on that amount. 

This is the closest to "timing the market" (and it isn't really timing the market in any real sense) I'll ever suggest to anyone - if you're ready to buy more of whatever you're invested in in taxable, check if it's about to issue a dividend.  The stock funds typically do this at the end of each quarter (end of March, June, September, and December), bond funds are, I believe, monthly (my bonds in taxable are, as are my bonds in tax-advantaged, but I haven't checked all their major bond funds).

This also makes no difference if you're buying a muni bond fund in taxable.

marty998

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Re: Question re: Vanguard mutual fund dividend payments
« Reply #8 on: March 18, 2013, 04:01:56 PM »
A share price in theory is the present value of all future dividend payments
CF= cashflows
r equals discount rate
share price = CF0 +CF1/(1+r) + CF2/(1+r2) +....CFn/(1+rn)

When a stock goes ex-div, CF0 is removed from the valuation, no surprise that the share price drops by that amount.

(Yes alright calm down finance wizards, I've left out growth rate and terminal value for simplicity)