Author Topic: Question regarding dividend investing and sequence of returns risk  (Read 1433 times)

RyanAtTanagra

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Not to beat a dead horse regarding dividend investing vs principle drawdown.  I know mathematically a 4% dividend payout vs 4% retained earnings that are then taken as sold shares should work out the same.  Not trying to have another discussion about that part again.  But I've been wondering about how the two methods effect sequence of returns risk.  I've heard people say that during the 2008 recession when stocks dropped 50%, their dividends only dropped about 10%.  Provided that over the long term the returns are the same between the two investing methods, would dividend income be less susceptible to sequence of returns due to less volatility?

I know it's hard to do comparisons with the current tools, but has this aspect been calculated yet?

Aphalite

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Re: Question regarding dividend investing and sequence of returns risk
« Reply #1 on: January 08, 2016, 01:27:29 PM »
Provided that over the long term the returns are the same between the two investing methods

They're not the same. Historically, dividend paying stocks AS A CLASS have returned more than non paying stocks AS A CLASS due to the following (bulleted list lifted from joshuakennon.com):

- The requirement to maintain a stabilized dividend rate may result in management taking on less risk or leverage to protect the expectations of the owners, leading to more prudent decisions that make surviving economic disasters easier.
- Management may not be as tempted to fund overpriced acquisitions since not all of the firm's cash is at their disposal.
- The dividend itself forms a sort of "yield support" during collapses that causes lower overall volatility levels than would otherwise be the case, which makes it easier to raise equity at more advantageous prices when necessary or advisable.
- The "return accelerator" function that was a central part of the work of Dr. Jeremy Siegel at Wharton, which we went over in the post on investing in oil majors, results in dividend paying stocks accruing more absolute wealth to their owners during times of market distress; a by-product of basic math.

Again, it's not BECAUSE these stocks pay dividends (which is the mathematical argument a few posters in this forum love to make - ie there's no difference because a dividend payment is accounted for in the stock price, which theoretically is true but misses the entire point), but the underlying mechanics and psychological motivations of investors behind the fact that there's a dividend being paid

If you need historical proof, here it is: http://www.suredividend.com/wp-content/uploads/2014/03/Dividends-A-Review-of-Historical-Returns.pdf

Note that the source data is from Kenneth French and CRSP, the file is hosted on a pro-dividend site, and that past performance does not always indicate future recurrence

You will always have stocks where management has a plethra of opportunities to reinvest in the business or where management prefers buybacks to dividends, which drives growth in share price (examples like Google and Autozone) and where there is no dividends being paid. But as a class, the academic evidence is more than clear.

Now, what do you do with this information?
If you are a know nothing investor and you don't have the ability or just don't want to spend the time to learn how to value stocks and evaluate businesses, it is best to IGNORE everything I've said as well as the questions you have asked, buy the entire market and keep turnover and costs low, as well as holding them in a tax efficient manner - an index fund in a tax sheltered account is your best bet for doing so
« Last Edit: January 08, 2016, 01:30:09 PM by Aphalite »