Author Topic: total stock vs 500 vs dividend growth  (Read 6920 times)

Stache In Training

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total stock vs 500 vs dividend growth
« on: December 15, 2013, 11:34:58 PM »
So I'm currently in the 500 index for most of the stock section of my portfolio. However, it seems that the total stock market index generally out performs the 500 index, and is essentially more "diversified."  So I was thinking of starting to invest there instead, while still keeping what I have in the 500 index. However, when I went to compare, just to see how they stacked up, I also included the dividend aristocrats fund:
https://personal.vanguard.com/us/funds/vanguard/compare?navigatingFrom=2
When looking at the numbers as to growth, it looks like total wins, but when you graph the growth of 10k (which includes if dividends are reinvested), you see that over longer periods, that the dividend growth wins out.

So my question is, since the expenses are higher for the dividend growth fund, would that cancel out the better performance?  If not, why not use dividend growth instead, since it seems to outperform the total index? 

I eventually would like to live off of dividends and not have to use principal, unless needed, which is why the dividend growth is so attractive to me.

dmn

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Re: total stock vs 500 vs dividend growth
« Reply #1 on: December 16, 2013, 03:49:21 AM »
Why not use dividend growth instead, since it seems to outperform the total index?

You only know that it has outperformed in the past. If you believe that markets are reasonably efficient (and evidence suggests they are), then the future risk-adjusted return on dividend stocks is not greater than that on other stocks.

For this reason, I think it is best to just minimize costs - under the constraint that one should maintain decent diversification to reduce risk.

seattlecyclone

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Re: total stock vs 500 vs dividend growth
« Reply #2 on: December 16, 2013, 11:49:53 AM »
I agree that the stock markets are reasonably efficient. One possible thing in favor of the dividend fund, if you're investing in a tax-advantaged retirement account, is that the market factors dividend taxes into the price of the stock to a certain extent. So a dividend stock will sell for slightly less in the current tax system than in a hypothetical tax system where nobody ever had to pay taxes on dividends.

As someone investing in a retirement account, you don't have to worry about dividend taxes. It's possible that you could outperform a broad market fund, even in an efficient market, by investing in things that other people avoid because of taxes.

Stache In Training

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Re: total stock vs 500 vs dividend growth
« Reply #3 on: December 16, 2013, 11:37:36 PM »
Ah, guess I should have said this, that it'll be in a taxed account.  (I like that dividends are taxed at a lower rate, though I bet the years right before FIRE, I'll be hosed in taxes from dividends and regular employment)  So does this change any of the advice?

Michread

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Re: total stock vs 500 vs dividend growth
« Reply #4 on: December 17, 2013, 07:12:47 AM »
I have all THREE in my portfolio (plus more)! 

k9

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Re: total stock vs 500 vs dividend growth
« Reply #5 on: December 17, 2013, 08:26:20 AM »
Dividend growth should not be compared to regular indexes on a total return basis. The major selling point of dividend growers is that they provide an ever growing cash flow, no matter what happens to their market value. P&G, JNJ, KO et al holders weren't hurt during 2008. "A krach ? What krach ? My cash flow kept growing this year as every year. Do you mean these cash machines are on sale ? That's good news, I'll buy some more, my cash flow will grow even faster".

On the contrary, with classical indexing, your dividend flow was reduced during 2008 (but, sure, stocks were on sale too).

It's more about everyone's temperament than about total return percentage. Some like to focus on their net worth. Other prefer to see how many cash they generate each month. No one is wrong. To each his own.

Stache In Training

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Re: total stock vs 500 vs dividend growth
« Reply #6 on: December 18, 2013, 12:04:10 AM »
While net worth is very nice, at the end of the day, I would rather have higher cashflow each month, than to have to tap into principal, unless needed (as I stated).  Just personal preference, as k9 said.  However, to have the cashflow, you would still need a pretty high amount invested, either way, right?  I mean, since the yield % is very close... Though I guess the growth fund % is "guaranteed" to not drop. 

Or could it be possible to reach FIRE quicker (Via just a higher constant cashflow?) than the 4% SWR math would indicate, if you're invested in the aristocrats; companies that never want to lower their dividend?  I mean it's riskier, since obviously no company is ever 100% un-touchable, and you don't have as much principal to withdraw from if you get in an emergency.  But is it possible, or maybe that is included in the SWR math.  I just always thought it was including some dividend payout, but also tapping into principal.

Sorry, just kind of rambled there, but hopefully someone will be able to make some sense out of my thoughts/questions.

fiveoclockshadow

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Re: total stock vs 500 vs dividend growth
« Reply #7 on: December 18, 2013, 05:31:05 AM »
How is a dividend stream tax wise better than capital gains?

You need to look at total return. The investor preference for dividends over total portfolio return is just a persistent cognitive error. It is pretty well studied in fact. Dividend growth is not a better performer than a portfolio of total market and fixed income.

grantmeaname

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Re: total stock vs 500 vs dividend growth
« Reply #8 on: December 18, 2013, 05:37:31 AM »
Stache in training, what do you think a dividend is if not tapping into your principal? That money comes from the coffers of the companies you invested in - it's equivalent to the company repurchasing its own shares and then you selling a few to undo the concentration, or to the company not spending the cash and using it to make more widgets. What about the dividend-paying process is magical? The fact that companies declare dividends reliably and consistently does not mean that the money comes from nowhere.

Stache In Training

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Re: total stock vs 500 vs dividend growth
« Reply #9 on: December 18, 2013, 11:34:08 PM »
Stache in training, what do you think a dividend is if not tapping into your principal?
So what I meant by tapping principal, is that the # of shares I own remains the same/never selling the share.  I realize where the dividend money is coming from and why.  But why I like it, is that I am still getting some money from owning the stock, yet never lose ownership of the share. (unless the company folds, obviously)

So say I have a dividend stock that increases from 5 dollars to 10 per share after 5 years. (These numbers are all purely hypothetical, obviously) However, I get paid 1 dollar every year.  So that one share would total to 5 dollars of dividend, and is worth 10 dollars, so total 15 dollars.  Compare that to another stock that goes from 5 to 15.  Total money seen from either share would be the same: 15, if sold at that point.  But, I would have to sell the non-dividend at 15 to see any money, and then I don't have that share.  So total return was more with the non-dividend, if you don't sell the dividend stock: 10 vs 5, respectively.  But then I'm done for the future b/c I had to sell that share.  Where as in 5 more years, that one dividend share has now paid 10 total, AND I still own the share.  Which still gives me the option to sell at whatever it's valued at, at that point in time.

That's why tapping principal in my mind is selling the share.  Maybe I'm using the wrong terminology? 
To me, if I can get dividend cashflow to cover my expenses, and never have to sell any shares, unless we have an emergency, my thought is, why not?  That's why I'm asking these questions.  I want to learn.  So where are the holes in my "why not?" logic?

How is a dividend stream tax wise better than capital gains?
Wait, I was told that that dividends were taxed lower than the gains of selling stock are taxed.  Are they the same?

grantmeaname

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Re: total stock vs 500 vs dividend growth
« Reply #10 on: December 19, 2013, 10:34:59 AM »
So what I meant by tapping principal, is that the # of shares I own remains the same/never selling the share.  I realize where the dividend money is coming from and why.  But why I like it, is that I am still getting some money from owning the stock, yet never lose ownership of the share. (unless the company folds, obviously)
Why does "the share" matter, though? If you sell shares or get the dividend, the amount of productive AT&T enterprise that you are the owner of decreases by the amount of the proceeds in either case. Nobody is going to count the number of shares you own, which will likely not be a whole number anyways, and the number is literally fully devoid of economic meaning.

Quote
So where are the holes in my "why not?" logic?
Poor diversification, concentration risk, less favorable tax treatment, and lack of investor control of whether or not you get a payout are the holes in your "why not?" logic. If you tell a very simple story in which there is only one share of a company, it's better, but when you expand it further to an actual company with multiple shares it's identical, and when you expand it further to a world with taxes and risk, it's worse.

Quote
Wait, I was told that that dividends were taxed lower than the gains of selling stock are taxed.  Are they the same?
Either they are the same or dividends are worse, depending on the circumstance. Dividends are never better.

k9

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Re: total stock vs 500 vs dividend growth
« Reply #11 on: December 19, 2013, 03:11:32 PM »
The thing is, the price of a stock depends on 2 factors : what its actual financial value is and what the market is ready to pay for it. It all boils down to the fundamental question : does the market sometimes overreacts or is it always efficient ? If it is efficient, dividend growth & indexing are quite the same. If it is not, what you have left when you sell a part of your capital is not exactly the same as what happens when cash is flowing out of the company straight into your pocket.

CanuckExpat

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Re: total stock vs 500 vs dividend growth
« Reply #12 on: December 19, 2013, 03:28:41 PM »
*If* you are seeing higher return with the dividend index, it may simply be reflecting the value premium, at the expense of higher volatility.

More discussion here:
http://www.cbsnews.com/news/should-you-follow-a-high-dividend-stock-strategy/
http://www.cbsnews.com/news/the-problem-with-high-dividend-strategies/
http://www.bogleheads.org/forum/viewtopic.php?t=61930

Stache In Training

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Re: total stock vs 500 vs dividend growth
« Reply #13 on: December 19, 2013, 03:40:44 PM »
Why does "the share" matter, though? If you sell shares or get the dividend, the amount of productive AT&T enterprise that you are the owner of decreases by the amount of the proceeds in either case. Nobody is going to count the number of shares you own, which will likely not be a whole number anyways, and the number is literally fully devoid of economic meaning.

I know that the number of shares owned is meaningless, but what's meaningful is that I'd still own the share. It can still produce an income. Look at it like a chicken vs a pig.  A pig will produce more meat than a chicken.  However to get that meat, you have to no longer own the pig.  However with a chicken, you'll continue getting meals for the life of the chicken, and then a chicken dinner at the end.  So that's kind of how I look at it.  Slow, constant payout, vs large payout with no chance of future earnings.  So that's why I say why not.  So to that you're saying that there's poor diversification (therefore more risk) in the dividend appreciation fund?  So you think there's a chance of skipping dividends in this fund?  Or can you expound on what you mean by these concerns?

Stache In Training

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Re: total stock vs 500 vs dividend growth
« Reply #14 on: December 19, 2013, 03:41:32 PM »
Thanks for those links, I'll check them out!

grantmeaname

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Re: total stock vs 500 vs dividend growth
« Reply #15 on: December 19, 2013, 03:53:35 PM »
If it is efficient, dividend growth & indexing are quite the same.
Except that dividends are treated unfavorably for tax purposes, and that managers may be unwilling to cut dividends when they would want to economically because of investor overreaction to what it signals about their investment prospects. And that some whole categories of companies, such as startups, don't pay out dividends, so you're losing diversification by only investing in dividend paying companies or dividend 'aristocrats'. So they're really not the same at all, due to all the market frictions that I mentioned above, even if the market is exactly, perfectly efficient.

Chickens and pigs
It's not about owning discrete units of something! Capital is a continuous phenomenon. You can't own three hundred and seventy-six ten thousandths of a chicken and have it do anything for you. 376/10000 of a share of a mutual fund is worth exactly that much of a whole share, while 376/10000 of a cow is worth nothing. There's nothing magical about whole numbers here!

Numerical parable to follow.
« Last Edit: December 19, 2013, 03:59:42 PM by grantmeaname »

grantmeaname

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Re: total stock vs 500 vs dividend growth
« Reply #16 on: December 19, 2013, 04:22:37 PM »
Here's an illustration:

Imagine that you have two IRAs in which neither capital gains nor dividends are taxed. In each account you have stock such that you own one percent of two one-million-dollar companies, Divcorp and Capgains – let’s say a thousand shares of each. Each has an unlimited menu of investment projects it can undertake that earn a return of six percent. Capgains pays no dividend, but Divcorp pays a dividend of five percent every year on the last day of the year. After two years you want $1,000 to buy widgets and clothe your kiddos, so you order $500 to be withdrawn from each account. After three years you’re curious how well your two account balances are doing.

Your 1000 shares of Capgains are worth $10,000, so the initial share price is $10. After one year it’s $10.60, and after two years is $11,236, with the security price having appreciated to $11.24/share. At that time, you need $1,000, so you go ahead and sell 44.5 shares. Your remaining 955.5 shares are worth $10,736. After one more year, at the end of year three, you have 955.5 shares of Capgains stock worth $11.91 each; the value of the account is $11,380.01.

What about your Divcorp stock? Your Uncle Rich told you it was a really solid company, as evidenced by its consistent dividend history, so you bought the same amount of it as Capgains corp. On the second-to-last day of year one, it was worth $10,600; then, the company paid out a dividend of $.53/share, which netted you $530. Your shares fell in value to $10,070, but you bought $530 worth of Divcorp stock at $10.07/share – an additional 52.63 shares. You have 1052.63 shares worth $10.07 – that’s $10,600. As you can see, in years that you reinvest dividends, the payment of the dividend does nothing at all.

Divcorp is just as prosperous as Capgains in year two, and your shares have appreciated from $10.07 to $10.67. On the second-to-last day of year two, your holdings are worth $11,236 – your shares, 1052.632, times $10.67. On the last day of the year, the board pays a 5% dividend; that’s 53.4 cents per share this year. Your shares are now worth $10.14, and you have $561.80 in cash. You reinvest $61.80 and buy 6.094 shares of Divcorp – so now you’ve got 1058.726 shares. At the end of year three, before the dividend is paid, the shares have appreciated to $10.75. How much are your 1058.726 shares worth? $11,380.

There is nothing magical about dividends. When a company pays you a dividend it is slaughtering chickens just as surely as you are slaughtering chickens when you sell a share. Even in a world without taxes, costly signaling, and so forth, the difference is that you can at least control the timing when you don't insist on a dividends strategy.
« Last Edit: December 19, 2013, 04:24:30 PM by grantmeaname »