Investing

Why Dividend Investing is not a great idea

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Deal Guru
Jan 27, 2006
14585 posts
7489 upvotes
Vancouver, BC
cloak wrote: Has it not been shown that psychological issues/concerns are among the main reasons people fall behind financially/as investors? (buy high, sell low) If DGI solves that issue for many... then it has added value there. Few people can manage purely cold and calculated decisions for extended periods of time.
I think psychological issues/concerns are the main issues for the ones that fall way behind. During the financial crisis, I had a colleague who freaked out seeing the market fall day after day that he sold everything that he had invested around the bottom of the market so he basically solidified his market losses. He hasn't been back in the market since. I would bet that many of those who were not in the market recently did basically the same thing regardless of what type of investment system/philosophy they might have followed.
Deal Addict
Sep 2, 2009
1024 posts
718 upvotes
Ottawa
craftsman wrote: I think psychological issues/concerns are the main issues for the ones that fall way behind. During the financial crisis, I had a colleague who freaked out seeing the market fall day after day that he sold everything that he had invested around the bottom of the market so he basically solidified his market losses. He hasn't been back in the market since. I would bet that many of those who were not in the market recently did basically the same thing regardless of what type of investment system/philosophy they might have followed.
Would be interesting to see what the results are of different strategies on emotional response (I am likely dreaming that a good one has been done). Since I doubt the the people that didn't sell are not the ones talking about it in 'real' life.
[OP]
Deal Addict
Nov 9, 2013
3912 posts
3598 upvotes
Edmonton, AB
cloak wrote: Would be interesting to see what the results are of different strategies on emotional response (I am likely dreaming that a good one has been done). Since I doubt the the people that didn't sell are not the ones talking about it in 'real' life.
It's an interesting question, but it would be hard to standardize as it'd be so personalized (i.e something that works well for me psychologically may not work well for you). Nonetheless, you can see the impacts of psychology has on investment returns with the behaviour gap.
Keep calm and go long
Deal Addict
Sep 2, 2009
1024 posts
718 upvotes
Ottawa
treva84 wrote: It's an interesting question, but it would be hard to standardize as it'd be so personalized (i.e something that works well for me psychologically may not work well for you). Nonetheless, you can see the impacts of psychology has on investment returns with the behaviour gap.
I agree, which is why I mentioned dreaming and good. However, if the sample size was large enough, trends can start to form on a population level which can start leading to generalizations (or not).

As an example, studies with a large sample size can show that accounts that are not touched, in general perform better than accounts that are touched. On a small sample size though, an account that was all between Enron and Nortel -and never changed- more than likely performed worse than an account that was touched/tweaked a lot.

I would not want to be the one writing out a proper methodology for a study that compares different investment strategies, on top of emotional responses, on top of longterm investing results...
Deal Addict
Jul 23, 2007
4156 posts
2256 upvotes
Some investors find major market downturns catastrophic. I've always had a different mindset since holding on to my companies while going through my first one in 1987. After the financial storm is over I find it a wonderful time to look to start patching up what I can for the weak links in my thinking and also in the portfolio itself.
Deal Guru
Jan 27, 2006
14585 posts
7489 upvotes
Vancouver, BC
cloak wrote: Would be interesting to see what the results are of different strategies on emotional response (I am likely dreaming that a good one has been done). Since I doubt the the people that didn't sell are not the ones talking about it in 'real' life.
I think it depends on how one measures 'returns'. If one does it by the size of the portfolio - ie a $1 million one one day and a $800 thousand one the next, you will probably see a similar reaction regardless of system/philosophy used. However, if you use the idea of monthly income - either by selling regularly or dividend or both - then, it might not be so bad as the bank account sees an input each quarter and if the account is large enough, the 'damage' is basically hidden from view.
Deal Addict
Sep 2, 2009
1024 posts
718 upvotes
Ottawa
craftsman wrote: I think it depends on how one measures 'returns'. If one does it by the size of the portfolio - ie a $1 million one one day and a $800 thousand one the next, you will probably see a similar reaction regardless of system/philosophy used. However, if you use the idea of monthly income - either by selling regularly or dividend or both - then, it might not be so bad as the bank account sees an input each quarter and if the account is large enough, the 'damage' is basically hidden from view.
I think that actually gets to some of the psychological aspects. A DGI growth method, at least historically in Canada, has been pretty stable and growing (despite large swings in capital).

A dividend portfolio clunking along at 2k dividends a month whether capital doubles or halves is mentally -in my opinion- probably easier to handle than selling 2k a month when stocks are halved (psychologically it can feel like 4k).

People and markets like predictability. And loss feels worse than gain.
Deal Guru
Jan 27, 2006
14585 posts
7489 upvotes
Vancouver, BC
cloak wrote: I think that actually gets to some of the psychological aspects. A DGI growth method, at least historically in Canada, has been pretty stable and growing (despite large swings in capital).

A dividend portfolio clunking along at 2k dividends a month whether capital doubles or halves is mentally -in my opinion- probably easier to handle than selling 2k a month when stocks are halved (psychologically it can feel like 4k).

People and markets like predictability. And loss feels worse than gain.
I think part of that is where the investor looks for signs of trouble. With most DGI companies, there aren't large gains in the stock price so investors may only check their monthly or quarterly statements as long as the dividends keep rolling into the bank account. But just like with a missed paycheque coming into the bank account, most people will notice if the account is missing that 2K but may not notice if it's missing $50 so the investor thinks everything is just fine as long as the bulk of the money rolls. It's only if the investor starts seeing a more sizeable amount of dividends not arrive in their bank account - ie $100 or more out of 2K - might they start digging into the trading account and find out that X company didn't pay which might be a several weeks after the announcement and a week or two after the typical payout date. By that time, the stock price may have actually rebounded a bit from the lows of the announcement taking away an immediate reason to sell seeing that the stock bounced back. After all, seeing a stock down 10% is a lot better feeling than seeing a stock drop 20%.
Sr. Member
Feb 13, 2008
522 posts
222 upvotes
Edmonton, AB
Dividend paying companies are a Ponzi scheme. They borrow money then pay it in the form of dividends!
Deal Guru
Jan 27, 2006
14585 posts
7489 upvotes
Vancouver, BC
cocotheparrot wrote: Dividend paying companies are a Ponzi scheme. They borrow money then pay it in the form of dividends!
Borrowing money to pay off investors isn't a Ponzi scheme. A Ponzi scheme is when a company takes investors money to pay off other investors to make it seem like the investments are paying off. New investors bring in more investors and those additional investor's money is used to pay off the older investors. Think pyramid scheme.

Since borrowed money doesn't come from investors but new creditors like banks, what you are describing isn't a true Ponzi scheme.

And as for how it applies to dividend-paying companies in general, it doesn't as most dividend-paying companies don't use investors' money to pay off other investors. You can say that some dividend-paying companies do borrow money in order to pay dividends but I would say that those are few and far between.
Deal Fanatic
User avatar
Dec 14, 2010
6085 posts
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cocotheparrot wrote: Dividend paying companies are a Ponzi scheme. They borrow money then pay it in the form of dividends!
Not all of them do. Look at levered cash flow vs operating cash flow (or adjusted funds from operations) vs free cash flow.

It's fundamentals and the ability of large companies to create wealth by generating cash flow and increasing earnings that will increase the value of these companies.

Dividend paying companies that pay and increase their payouts cannot continue to do so if they are not creating wealth and cash flow, which is why I'm not afraid of market corrections.

Think of it this way...if you are investing in a company that pays a 4% dividend and has a history of increasing that dividend for say, 25 years...think the shareholders are going to be satisfied with less then what they have had over the previous decades of cash payments? Companies will grow in a sustainable way to continue the ability to provide that growing income.

In periods of market declines, when a dividend payer continues to pay dividends: if you do not need the income, and reinvest dividends, you are using said dividends to buy more of that company in which even in down periods you buy even more of it. That means you get more dividends in the future and more shares, and provided fundamentals stay solid (which can be monitored), you are buying a company that will reward it's shareholders with not only more income, but increased future share price as the dividend yield will go back to normal when the market correction ends and normal behavior returns.

Investing for retirement means you are building a business that pays you income to replace your earnings from work. Bonds at their current rate hold much more risk at .25%-4% current yields. It is not like bonds would not be punished if interest rates rose 1 or 2 % over the next few years as the Fed ends QE, and we return to normal interest rates in the range higher than today, depending on inflation.

So pick your poison...do you want to own a business that has a history of increasing its ability to generate capital? Or do you want to loan them money at historically low interest rates with no inflation hedge with and hope inflation is not ever going to increase?

Companies are not taking higher debt to grow dividends. Dividends come from cash flow, and unless a business have a growing operating cash flow, they can't keep growing dividends.

Higher debt doesn't always mean more problem. Companies use debt to fuel growth, which drives earnings higher. And stock price follows earnings. These companies, that are still investment grades, need to be looked individually, regardless of the economy or a bear market that is usually caused by a recession.

Here is why they shouldn't stop raising dividends to pay their debt:

First, the government encourages businesses to use debt by allowing them to deduct the interest on the debt from corporate income taxes.

Second, debt is a much cheaper form of financing than equity. It starts with the fact that equity is riskier than debt. Because a company typically has no legal obligation to pay dividends to common shareholders, those shareholders want a certain rate of return. Debt is much less risky for the investor because the firm is legally obligated to pay it. In addition, shareholders (those that provided the equity funding) are the first to lose their investments when a firm goes bankrupt. Finally, much of the return on equity is tied up in stock appreciation, which requires a company to grow revenue, profit and cash flow. An investor typically wants at least a 10% return due to these risks, while debt can usually be found at a lower rate.

These facts make debt a bargain. It would not be rational for a public company to be funded only by equity. It’s too inefficient. Debt is a lower cost source of funds and allows a higher return to the equity investors by leveraging their money.

So why not finance a business entirely with debt? Because all debt, or even 90% debt, would be too risky to those providing the financing. A business needs to balance the use of debt and equity to keep the average cost of capital at its minimum. This metric is called weighed average cost of capital or WACC.

There are hundreds of companies paying dividends for consecutive years, many raising them. Which ones, that have doing so consistently for years, are borrowing to pay dividends? You can identify it by reading their financial statements. It doesn’t last, and dividends gets slashed in a few months.


Rod
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Deal Addict
Aug 17, 2008
4323 posts
3466 upvotes
@rodbarc Thanks for bring up WACC. I've avoided this whole discussion because the main troll/flat earth member didn't know about Risk On, Risk Off and just discovered Tail Risk, so there was absolutely no way he would know what WACC is.
[OP]
Deal Addict
Nov 9, 2013
3912 posts
3598 upvotes
Edmonton, AB
MrMom wrote: @rodbarc Thanks for bring up WACC. I've avoided this whole discussion because the main troll/flat earth member didn't know about Risk On, Risk Off and just discovered Tail Risk, so there was absolutely no way he would know what WACC is.
He (or she?) hasn't been around much as of late, perhaps he's found somewhere else to satisfy his confirmation bias?
Keep calm and go long
Deal Guru
Jan 27, 2006
14585 posts
7489 upvotes
Vancouver, BC
treva84 wrote: He (or she?) hasn't been around much as of late, perhaps he's found somewhere else to satisfy his confirmation bias?
The current bit of quietness fits the past SOP - nothing and then pops up to create chaos then disappears again.
Newbie
Jul 22, 2018
70 posts
40 upvotes
cocotheparrot wrote: Dividend paying companies are a Ponzi scheme. They borrow money then pay it in the form of dividends!
Why would you give money to company simply for them to return it. the whole point of a company going public is to generate capital to grow. once it cannot grow apparently the plow is to issue dividends to help investors do mental gymnastics into believing they arent risking their money but more so getting a paycheck every month/or so.

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