Why the Return from Dividends Matters

bee

Short but sweet explanation the role dividends (total return) play in the S&P 500 index:

Some of the responses on Twitter weren’t terribly impressed. To generalize, they said,“so what, it’s just a 2% dividend yield. Big deal.”

But in my view, it’s a very impressive chart and it shows us the importance of dividends.

Allow me to explain.

why-the-return-from-dividends-matters

FD1000

QQQ pays much lower than SPY
10 year average annually...SPY 13.5%...QQQ 20%.
I only believe in TR(TOTAL RETURNS) which includes all parts.
Even as a retiree I still look at TR because I can always sell something when I need cash.

WABAC

Long discussion from the guys that run the equity sleeve at VWINX and part of the portfolio at VEIRX.

Corrected thanks to @Sven.

Mark

@FD1000 - How do you know that everyone else isn't investing for TR as well using their dividends as just one piece of the equation? What if they aren't comfortable or knowledgeable enough to be trading in and out of positions? Or simply don't have the time? It doesn't necessarily have to be all or nothing you know. Their are infinite ways to climb the mountain.

Sven

Thank you for the insightful M* interview that shed more light on the equity side of VWINX.

Gary1952

Mark said:

@FD1000 - How do you know that everyone else isn't investing for TR as well using their dividends as just one piece of the equation? What if they aren't comfortable or knowledgeable enough to be trading in and out of positions? Or simply don't have the time? It doesn't necessarily have to be all or nothing you know. Their are infinite ways to climb the mountain.

It's TR first and yield second. 6.5% TR difference is pretty substantial to be worried about 2% yield. The other variable is catching all parts of the market in SPY.

FD1000

Mark said:

@FD1000 - How do you know that everyone else isn't investing for TR as well using their dividends as just one piece of the equation? What if they aren't comfortable or knowledgeable enough to be trading in and out of positions? Or simply don't have the time? It doesn't necessarily have to be all or nothing you know. Their are infinite ways to climb the mountain.

My point is to show that a typical investor doesn't need to worry about yield and just invest longer term mostly in indexes such as SPY/VTI and if you want more tech you can use QQQ.
I don't see any advantage looking for higher yield stocks as it doesn't guarantee better performance or volatility. The index thru adjustment will take care of the winners and losers.
Lastly, even retirees don't have to invest for higher yield, they can always sell something. Most retirees invest in stock+bonds funds and get monthly distributions.
If they need more: when stocks go up they can use their stocks for expenses, when bonds are up use their bonds.

Mark

That alleged TR advantage is premised on the basis of never touching your balance and allowing it to just grow and grow and grow. Tell me, who does that? Who just lets it sit there forever and ever? This constant battle between dividend growth/income focused investors and TR investors is a total waste of time and nonsense. Who cares as long as the investor is getting what they want.

Sure I can sell shares but there are no guaranties that I will always be selling them at an advantage. Similarly theres no guarantee that a dividend is safe and secure forever but it's more likely. And no where is it written that all income investors go after higher yields all the time.

davidrmoran

FD1000 said:

My point is to show that a typical investor doesn't need to worry about yield and just invest longer term mostly in indexes such as SPY/VTI and if you want more tech you can use QQQ.
I don't see any advantage looking for higher yield stocks as it doesn't guarantee better performance or volatility. The index thru adjustment will take care of the winners and losers.
Lastly, even retirees don't have to invest for higher yield, they can always sell something. Most retirees invest in stock+bonds funds and get monthly distributions.
If they need more: when stocks go up they can use their stocks for expenses, when bonds are up use their bonds.

+1

msf

Sure I can sell shares but there are no guaranties that I will always be selling them at an advantage.

Whether you sell or not, that's effectively what's happening when a fund pays a dividend. Generally when funds receive dividends and interest from their underlying stocks and bonds they plow that money back into their portfolios. They don't hold that money as cash for their next periodic (e.g. quarterly) dividend payment.

They may gradually build up cash near the end of the quarter (for quarterly divs), but that's still basically selling off holdings for cash. There's no guarantee that they are raising cash when their holdings are richly priced. Just as you wrote.

There are a very few exceptions, a handful of archaic ETFs structured as unit investment trusts. By law, UITs do not reinvest their interest and dividends when received, but hold that money as cash to pay all dividends. This creates a cash drag.

Ironically, both SPY and QQQ are UITs. So unlike the vast majority of funds, they never have to sell their holdings to pay their dividends. You may get slightly more stability, but on average it's a loser. This is one reason why I prefer VFIAX (better performance than SPY without a cash drag).

MikeM

I like and use the philosophy of TR, but if you are in withdrawal stage or near to that, I highly recommend a safe "withdrawal bucket" or whatever you want to name it as a safe guard to selling low. I don't invest based on dividends or income but that's just me. I have a 3-4 year expense withdrawal bucket made up of cash, bonds and what I consider a bond alternative that allows me to let total return ride so that I can replenish that safe bucket only when investments are up.

That's the plan anyway. Still working so I haven't started drawing from it yet.

The other point to make is there is more than 1 way to skin a cat. Using dividends to supplement income is a tried and true method for retirees also.

davidrmoran

MM, what is your 'bond alternative'?

WABAC

Sven said:

Thank you for the insightful M* interview that shed more light on the equity side of VWINX.

Thank you for the correction.

MikeM

@davidrmoran, MNWAX, a very conservative L/S fund. My expectations are 3-5% per year from it so that is why I'm referring to it as a bond alternative. Seems to have low correlation to equity and bonds. I first saw this in one of David's commentaries on top 25% list for LS funds. Not for everyone I'm sure.

FD1000

Mark said:

That alleged TR advantage is premised on the basis of never touching your balance and allowing it to just grow and grow and grow. Tell me, who does that? Who just lets it sit there forever and ever? This constant battle between dividend growth/income focused investors and TR investors is a total waste of time and nonsense. Who cares as long as the investor is getting what they want.

Sure I can sell shares but there are no guaranties that I will always be selling them at an advantage. Similarly theres no guarantee that a dividend is safe and secure forever but it's more likely. And no where is it written that all income investors go after higher yields all the time.

I stated in my post the following: "Lastly, even retirees don't have to invest for higher yield, they can always sell something. Most retirees invest in stock+bonds funds and get monthly distributions.
If they need more: when stocks go up they can use their stocks for expenses, when bonds are up use their bonds."

TR doesn't mean you never sell. You do sell when you need some money and I explained how to do that. And no, you don't sell your stock funds at the bottom, this is why retirees have bond funds.

Can you show where is the fault with this approach?

BTW, I look at best risk/reward funds and after I like that I may go for higher yield but in no circumstances I would invest based on higher yield first. QQQ made a lot more money than higher yield (income or value) stock funds but also did better on March meltdown. The investing world changed, information is known globally in minutes, high tech companies improve processes, they get their next customers quicker and cheaper. It's a lot harder to find unknown great companies and if you find that their price goes up pretty quickly.

=========
The bucket system: why the average Joe should use this system? Why anyone wants to make it more complicated than necessary?
Let's take a simple example: Joe the retiree knows his goals and came to a conclusion that 50/50 is the right mixed, he bought 4-6 funds and from that points, when stocks go up he uses stocks for expenses, when bonds are up he uses bonds. This will also take care of his asset allocation but if markets are extreme he decides to rebalance if his portfolio is off by 5%. Pretty easy concept to follow and implement.

The bucket system takes the above simple approach and complicates it without any evidence it's better for performance or volatility.
Others own 15-20 funds instead of just several. Again, why?

Just because you can handle it doesn't mean you have to

MikeM

FD, did anyone ask for your opinion? Don't want it. Don't need it.

FD1000

Hey MikeM, you are not the only poster in MFO. My posts are generic for anybody who is interested. The way we grow is thru exchange of ideas.

MikeM

Your comments are pointed, ego-centric and certainly not generic. Don't post to any of mine. Please

WABAC

Mark said:

That alleged TR advantage is premised on the basis of never touching your balance and allowing it to just grow and grow and grow. Tell me, who does that? Who just lets it sit there forever and ever? This constant battle between dividend growth/income focused investors and TR investors is a total waste of time and nonsense. Who cares as long as the investor is getting what they want.

Sure I can sell shares but there are no guaranties that I will always be selling them at an advantage. Similarly theres no guarantee that a dividend is safe and secure forever but it's more likely. And no where is it written that all income investors go after higher yields all the time.

IMO M* is almost always negative about dividend investors. One of the reasons I stopped subscribing. Seems to me that their TR story is wrapped up in the market of the 80's - 90's they grew up with.

On your other topic:

When it gets to the stage that you have to sell retirement assets because of need, or legal requirement, this is where I think about turning our IRA's into annuities. My wife is already in the TIAA-CREF ecosystem. And theoretically she will out live me.

The accumulation of retirement assets phase is one thing. The liquidation of those assets in the best possible way over the next thirty years is another phase altogether.

FD1000

MikeM said:

Your comments are pointed, ego-centric and certainly not generic. Don't post to any of mine. Please

ego-centric, wow, what a guy.

I have been reading plenty of articles and research about the bucket system and can't see its necessity and superiority.
Kitces is one of my favorite writers. See his (article)
quote below

many advisors and their clients use strategies that will avoid taking distributions from asset classes like equities during down years – for instance, setting aside “buckets” as a reserve against market crashes, and/or creating a series of “decision rules” that might simply state outright that equities will only be sold if they’re up, otherwise bonds are liquidated instead, and cash/Treasury bills will be used if everything else is down at once.

Yet when such a decision-rules strategy is paired with simple rebalancing, it turns out that the outcome is no better than merely managing the portfolio on a total return basis without the decision rules at all! The key, as it turns out, is that rebalancing alone already has an astonishingly powerful effect to help avoid unfavorable liquidations, as the process systematically ensures that the investments that are up (the most) are sold, and the ones that are down (the most) are actually bought instead! Which means in the end, we may not be giving rebalancing nearly the credit it deserves to accomplish similar – or even better – results than buckets and decision rules alone, and that such approaches are better purposed as explanatory tools for clients than actual systems for generating cash flows in retirement!

msf

A pretty obvious academic exercise, but basically a straw man.

The key, here, is the ... sentence: once a portfolio is going to be rebalanced every year, the impact of decision rules is made null and void and the buckets are essentially just an asset allocation mirage, because the total amount of withdrawals is always the same (regardless of which asset classes it’s taken from) and the final allocation is always the same (due to the rebalancing).

The latter part of the sentence provides the explanation of why the two approaches come out the same. Hence my characterization of the substantially equal results as pretty obvious. However, the assumption that the portfolio be rebalanced annually, even if stocks and bonds are both down, is not realistic. Hence I take this theoretical equality to be a straw man.

If the cash bucket is to be replenished annually come hell or high water, what's the point in keeping more than a year's worth of expenditures in that bucket? In the real world, that cash bucket serves as a buffer for extended periods when both stocks and bonds are down. As Christine Benz describes the cash replenishing process:

In a good year for stocks, like 2013 or 2014, the retiree will be selling highly appreciated parts of the equity portfolio. If bonds have gained at the expense of stocks, the retiree would be lightening up on bonds. And if neither stocks nor bonds had appreciated, the retiree might allow bucket 1 to be drawn down, or even move into "next-line reserves" in the bond portfolio.

https://www.morningstar.com/articles/754593/retirement-bucket-basics-a-qa-with-morningstars-ch

You might have better luck with Moshe Milovsky's work, since he looks specifically at using the cash bucket without replenishing in down years. In a simplistic example, he shows that in the worst case (when the cash bucket is too small) the bucket approach can leave one with less. Fair enough, but is that an argument against the bucket approach or for allocating an adequate cash bucket?

He goes on to observe that in his example "there is a 60 percent chance [that a bucket approach] will be better off and a 40 percent chance [that a single balanced fund] will be better off. Indeed, the odds might favor [the bucket approach], but this is not a guaranteed way to avoid a poor sequence of returns."
https://www.thinkadvisor.com/2007/06/01/lesson-5-spending-buckets-and-financial-placebos/

P.S. Kitces describes the superiority of the bucket approach:

[A]s advocates of the strategy often point out, the bucket approach is arguably superior from the perspective of client psychology; it fits far better into our mental accounting heuristics, and makes the portfolio easier for clients to understand. Furthermore, clients may have an easier time staying the course through market volatility when they can clearly see where their cash flows will come from in the coming years, and that they truly have a decade or more to allow for any declines in the equity bucket to recover.
...
[E]ven if a bucket strategy merely produces the exact same asset allocation and portfolio construction, but does so in a manner that makes it easier for clients to stick with and implement the strategy, it is arguably a superior one.