34. Re-Thinking Dividend Paying Stocks for Retirement Income & Mark's Top 5 Holiday Movies
Dividends
b. The preference for dividends – 3 myths
i. Free cash in the form of dividends
ii. Dividend stocks beat the market
iii. Dividend stocks are more stable than other forms of income in retirement
(Myth 1) Free Cash in the form of dividends
i. Investors believe that cash dividends are like a free lunch -
ii. In reality, as soon as a company pays a dividend, the value of the shares of that company drop by roughly the amount of the dividend
1. For example, if Company A is worth $10 a share, and cuts a dividend for $0.25, the shares immediately afterwards are worth $9.75.
2. There is a misconception that once the company pays out the dividend that the stock price is unaffected. This is false
3. It makes sense, if that money has left the company, the company is now worth that much less
(Myth 2) Dividend Stocks beat the market
i. Investors believe that dividend stocks beat the market
ii. This is kindof true, but not because of the dividends
iii. There are several factors that explain the differences in returns between stocks, those factors are – relative value, size, profitability
iv. Many dividend paying stocks just happen to have these characteristics
v. It becomes a chicken vs. Egg debate – ie. Do dividend stocks outperform because they pay dividends? Or, do stocks that have more presence of the factors tend to be dividend payers? (value, size, profitability)
vi. To study this, lets use an example from Larry Swedroe's book: Your Complete Guide to a Successful and Secure Retirement
vii. Larry looked at 3 US Dividend funds against 2 total market funds from Dimensional and Vanguard, neither of which had a preference for dividends
1. In the period studied the DFA and Vanguard funds beat the Dividend-only funds in terms of total returns
(Myth 3) Dividend Income is more stable than other forms of income
i. Investors believe that dividends are steady and reliable as a source of retirement income, so they are prepared to accept some underperformance
ii. In a study published by Dimensional Fund Advisors showed that dividend payouts by Global Companies fell meaningfully in the first 3 quarters of 2020 compared to 2019
iii. Non-US developed companies – 41% decrease in dividends
iv. Emerging Markets companies – 29% decrease in dividends
v. US companies – 22% decrease in dividends
vi. The same phenomena played out in 2008 in the great financial crisis – so this is not just limited to 2020
So, Why the preference for dividends?
i. Paper by Hersch Shefrin and Meir Statman written in 1983 called "Explaining Investor Preference for Cash Dividends"
1. Natural Brake on spending
2. Prospect Theory – people experience gains and losses differently (also known as loss aversion)
a. In a down market, an investor would prefer to spend a cash dividend over creating a self-made dividend and selling a stock that has decreased in value
b. But, in reality, it is the exact same thing
3. Regret Avoidance – situation
a. Take $600 of dividends to buy a TV
b. Sell $600 worth of a stock and buy a TV
c. After the purchase, the price of the stock rises significantly
d. For many investors the sale of the stock causes more regret than spending the dividend (this comes back to the free dividend fallacy)
4. Paper also highlights that the preference for dividends increases with age
a. Older investors exhibit behaviours that demonstrate a more intense preference for dividends than young investors
In reality, investors are taking more risk for no compensation – they are acting like the neighbor that will only drink rainwater from his well, vs. The neighbor that has no preference
1. Only 40% of global stocks and 60% of US stocks pay dividends
2. Investors who say "only dividend stocks" are taking away the benefit of diversification in exchange for no added expected return
3. The rational way to build a portfolio of stocks is to diversify across equities, tilted towards factors (value, size, profitability)
4. Cashflow can be generated by dividends AND capital gains (ie. Self-dividends), and Bond Interest (for bond investors)
a. In fact, capital gains for taxable investors are actually more tax-efficient than dividends
Top Christmas Movie recommendations
A. Home Alone - McAuley Culkin, Joe Pesci, Daniel Stern (Family Stone)
B. Family Stone - Sarah Jessica Parker, Diane Keaton, Dylan Mulroney, Rachel McAdams, Clare Danes
C. Four Christmases - Vince Vaughan, Reese Witherspoon, Robert Duvall (church scene, Vince Vaughan plays Joseph)
D. Elf - Will Farrell
E. A Christmas Story - Peter Billingsley (later in The Breakup, Four Christmases)
Announcements for New Year
A. Interviews – mortgage advisor, lawyer to discuss powers of attorney, insurance advisor (long-term care), and a guest from Dimensional Fund Advisors
B. If you have questions, write to me at retiremepod@gmail.com
C. Wishing you a Merry Christmas, Happy Holidays, and a Happy New Year!
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Disclaimer - This podcast is for informational purposes only. Please consult with a financial advisor familiar with your unique financial situation before making any decisions. Nothing in this broadcast constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. Mark Walhout is the owner and lead financial advisor at Walhout Financial and an Investment Fund Representative at Investia Financial Services Inc.
Dividends in the Time of COVID-19 (dimensional.com)
Amazon.ca : Your Complete Guide to a successful and secure retirement