Do Dividend Paying Stocks Pay?
The stockholder wants both income and appreciation, but in general the more he gets of one the less he realizes of the other.
If you ask around, you will find that it is very common for investors to like dividends when searching for something to invest in. This is why REITs, bonds, dividend-paying “blue chips” and to some extent, property (through the rental income), are hot favourites amongst many investors. After all, the capital gains (or losses) of other investments are typically on paper and no tangible benefit can be felt — unlike the receipt of a dividend payout via a cheque or bank deposit. As such, it is no surprise that many investors then seek an income-focused approach either for the yield or the purported safety during a market drawdown.
Let’s look at some of the common income strategies and asset classes. Unbeknownst to many, these income-seeking strategies come with considerable risk, such as a high concentration in dividend-focused equities and a high exposure to high-yield bonds that don’t behave like bonds at all - very much more like equities.
Source: Vanguard
Unfortunately, these strategies do not offer the protection that investors seek and often lead to heightened volatility and a greater drawdown during times of market stress. During the recent COVID-19 induced bear market, such strategies had higher losses into the market bottom when compared to globally diversified equity portfolios, balanced portfolios and diversified bond portfolios (see below).
There is also an assumption that dividends are able to help investors to weather the high inflationary environment now - essentially an inflation protection vehicle or to help make a stock’s total return less volatile. This could very well be a misconception as the data below shows. Data taken from 1928 to 2021, and specifically measuring periods when inflation was high (an average of 5.5% annually) shows that there isn’t any strong evidence that dividend paying stocks were able to deliver outperformance versus their non-paying peers.
There is also financial commentary by investment strategists and asset managers out there that suggest that high dividend stocks are able to outperform other strategies in rising rate environments. Comparing monthly performance of high paying stocks vs low paying or non payers since 1934 shows that this argument is unconvincing. The returns of high paying stocks is not significantly higher than other sectors of the market.
So what should investors do? The data shows that there is no compelling evidence to purposely seek out high dividend paying strategies for the supposed protection or higher returns during turbulent environments. For most investors, a total-return approach which generates income from both capital gains and portfolio yield is the more robust long-term solution. Why is this so?
Diversification - total return strategies are more diversified and the portfolios are not skewed purely to income producing assets. As it is more diversified across various asset classes, it would be less volatile and would be able to hold up better during market shocks.
Higher Control - total return strategies push the control of the timing and size of the withdrawals into your hands. There is no variable dividends or income (like what happened in 2020 when nearly all companies suspended dividends during the COVID-19 crisis). You can also decide when to receive the payouts with the ability to take more during years that are good, and to receive a little bit less during bad years in order to preserve portfolio values. This way, your investments and savings could last for decades.
If you would like to find out more about how a total-return investing approach can help you generate a sustainable long-term payout and help your portfolio last as long as possible, come and have a chat with us.
