Why dividend collectors usually achieve less return

If you believe the blogs about dividends, then dividends appear the easiest way to really get passive income. Financial freedom with dividends or similar slogans are repeated mantra-like. Without a dividend strategy one seems to be able to achieve success according to some forums. One can build his dividend depot with cheap and easy to handle ETF dividends.

Dividend shares also have many advantages and form the basis of many strategies for asset building. Even looking in a dividend calendar and jumping from ex-dividend day to the next is used as strategy to collect upcoming dividends. Without question, dividend portfolios are popular. Many investors prefer this because they are looking forward to the regular “cash flow” on their account. This group of investors, also known as dividend collectors, sees only those shares which would pay as high a dividend as possible. And at times when conventional money investments, e.g. fixed-income or bonds hardly bring interest, this seems quiet justified.

But as everywhere – Where there is light, there are shadows. There is a lot of talk about dividends, but it has to be said that dividends also have serious disadvantages.

.

dividend

What is a dividend?

Dividends are called the profit distributions of stock corporations. In general, companies can pay dividends to their shareholders, but they do not have to. At the annual general meeting of the shareholders, a decision is made as to whether dividends should be distributed at all, and if so, how high they will be. The dividends are then paid on the so-called ex-dividend date, which has been fixed since January 2017 for the third business day following the annual general meeting. Anyone who gets the respective shares at this closing date until the closing date shall receive the dividend.

What is a dividend yield?

The total return on a share investment (also known as equity return) is made up of two components: the price yield and the dividend yield.

This means that the dividend yield is only part of the total return and in no case an extra payment.

The dividend yield is calculated as follows:

Dividend yield = dividend / share price

Thus, if you leave taxes and transaction costs aside, it makes no difference whether a share increases by 7% per year and does not pay a dividend, or increases by 5% in the price, and a dividend yield of 2%.

dividend

Does a good dividend yield automatically mean that it is a good company?

Not at all! A high dividend may also result from the fact that the price of this share fell sharply in the run-up to the year. This is most easily illustrated by the following example:

Company X pays out a dividend of € 2 per share for three consecutive years. However, the price of the share falls steadily over the same period. This results in an annual increasing dividend yield, with a simultaneous fall in the return on stock yield.

Year 1:

Dividend: 2€

Price: 80€

Dividend yield: 2,5% (2€/80€)

Year 2:

Dividend: 2€

Price: 60€

Dividend yield: 3,3% (2€/60€)

Exchange rate: -25% (-20€/80€)

Equity return: -21,7% (-25% + 3,3%)

Year 3:

Dividend: 2€

Price: 45€

dividend yield: 4,4% (2€/45€)

Exchange rate: -25% (-15€/60€)

Equity return: -20,6% (-25% + 4,4%)

Despite the rising dividend yield, the purchase of this share is anything but a good buy, as price and share returns fall significantly.

Often companies also pay good dividends to bait buyers to buy the falling stocks.

It should also be borne in mind that high dividends are not always accompanied by high profits. In part, they are simply a sign that the company management does not realize future investments.

So, it is quite significant that many innovative internet giants such as Alphabet (Google) or Amazon do not pay out dividends, because they prefer to invest all profits immediately in the development of new business fields. Others, on the other hand, prefer to buy stocks back with the money, which is positively seen by large institutional investors. Often this is also done because the manager’s salary is tied to the performance of the share price. And this of course benefits from share buybacks, while the payment of a dividend leads to a price loss.

Sometimes the business concept itself is simply not very promising. For a long time, two major energy companies were among the DAX companies with the highest dividend yields. The price of the stock itself was relatively low, although the companies made a profit as investors saw financial problems already coming.

If is therefore absolutely not advisable to use the dividend yield as the sole selection criterion forthe acquisition of shares. Rather, other aspects have to be analyzed in order to develop a viable dividend strategy for dividendcollectors.

Further selection criteria for dividend strategies

If, however, the motivated dividend collector wants to use a dividend strategy, further criteria should be taken into account.

Shares should be preferred by companies with constant or even rising dividends over the past 10 years. Companies that do this over 25 years are called dividends aristocrats.

Furthermore, the criterion is that 25-75% of the profits have been distributed to the shareholders in the last 3 years and the dividend yield has been at least 1% in recent years.

At this point, however, we want to emphasize once more clearly that it is ultimately the total return on a stock investment and not just the dividend yield.

7 Disadvantages of dividend strategies

In the following, we have listed the main disadvantages of dividends.

  • 1. Dividends, unlike interest, are not guaranteed

    Many media praise dividends as the „new interest “. However, this is not totally correct, as interest is contractually determined, while dividends are a voluntary payment of the corresponding companies, which can be deleted at any time

    These dividends are a profit sharing for the shareholders, and this only paid if profits have actually been made.

    Like this, many companies have significantly reduced or even completely suspended their dividend in the 2008 crisis.

  • 2. Dividends have a major impact equity prices

    If a company pays dividends over many years, this stabilizes the share price. If the dividend payments are canceled due to economic problems, the price of this share is double as investors are likely to lose shares due to lower dividends.

    It should also be remembered that dividends do not constitute an additional income which is to be attributed to the price gain. The distributed dividend rather reduces the share price. A stock with a value of 50 Euros, after the dividend distribution of 3 EUR is only 47 EUR worth. This is called dividend discount. This correction is taken by the exchange on the next trading day.

    It would therefore be equally possible to sell equities at the same rate, rather than reckon with dividend payments that lead to a loss in the value ofthe share. The dividend investor has therefore not received any additional income with the distribution. Instead, he even has to pay tax on the distribution and suffers a double disadvantage. (see point 4)

  • 3. The investor has no control over dividends

    Investors have little influence over the form and nature ofthe dividend as this is divided at the Annual General Meeting, where of course the major shareholders will pursue their interests. The decision on special dividends or dividends in the form of shares and the absolute amount of the dividend can therefore not be influenced in practice.

    This also applies to the time when the dividends are distributed or how often. These aspects are decided by the company and are not within the sphere of influence of smallholders.

    This is especially important when fiscal aspects or liquidity requirements come into play. If you have to pay your bills today, the dividend in 6 months is of little use.

  • 4. Dividends have significant tax disadvantages

    For dividends, the withholding tax must be paid in Germany in general. In addition, there is also the solidarity surcharge. There is, however, an exemption on capital gains which slightly reduces the tax burden on small investors, and shareholders can also tax their capita income according to the personal income tax rate, provided this is less than 25 percent, but still remains a considerable amount of taxes.

    For many foreign dividends, such as the USA, Canada, the Netherlands, France, Switzerland or Italy, the so called withholding tax is applied which is deducted directly from the country in which the company is based. The withholding tax can be up to 30 percent of the dividend in some countries.

    The most serious thing is that dividend income may not be offset against share price losses. For example, for a dividend of 2 Euros on a stock that costs 20 euros, you have to pay 0.50 euros withholding tax, although the stock is now only worth 18 euros, so the bottom line is no profit at all. If the share price even goes down totally, a loss will ultimately be lost, but the dividend income must still be fully taxed.

  • 5. Dividends reduce profit opportunities

    If you focus on dividends alone and leave shares on the left that do not pay dividends, your selection of investment option is extremely reduced.

    The system is particularly sensitive to strict criteria such as the stability of dividend (e.g. never a dividend reduction), the historical growth of the dividend (regularly rising dividends) or the duration of the dividend (in some cases over 100 years).

    Who uses these criteria as a filter, misses opportunities such as Microsoft, Apple or Google. Other strong corporations such as the Warren Buffet company– Berkshire Hathaway– or Gilead Sciences did not pay dividends during the period of the greatest growth. In such cases, investors waived a dividend of 2-3 percent on price gains of 20 to 30 percent per annum.

  • 6. Insufficient risk diversification / diversification

    Investors who pursue a dividend strategy generally operate so-called stop picking. The search for individual stocks according to a single search criterion negatively impacts the important risk diversification (diversification). This automatically leads to a higher risk of volatility.

    And without compensating by a corresponding risk premium!

  • 7. Exclusion of so-called small caps

    DividendCollectors neglect part of the equity market, which has surpassed the overall market by an average of 3 percent per year – the so-called small caps.

    This refers to small companies with a stock market value of less than two billion US dollars. And as a rule, they do not pour out any dividends.

    The omission of small caps as an asset class thus automatically leads to a renouncement of a yield optimization of the entire portfolio.

Can dividend strategies be functional anyway?

The answer is yes, but not from the reasons assumed by the dividend collectors.

Many dividend collectors have properties that make long-term investment possible:Typically , they are disciplined savers.

  • • They buy stocks to keep them longer-term “buy-and-hold”.
  • • Their portfolio contains a high proportion of shares.

Dividend strategies with ETF dividend

All investors anddividends collectorswho do not wish to implement a dividend strategy with individual shares can of course resort to fund solutions.

In doing so, we rather advise to index funds (ETFs), as they actively beat the actively managed products in terms of performance.

It is important, however, that ETFs also carry out a detailed audit on dividends, in particular on the number of individual titles, in order to ensure a reasonable risk diversification.

In addition, adjustments can be made more frequently due to dividend payments. This occurred three times in 2015. In March 2015, for example, the Linde share was taken up shortly before it began its dive, and it was thrown out again in September 2015. During this time, the stock showed a performance of – 23,4%.

An investment in dividend stocks around the world is, logically, the highest level of risk diversification. Unfortunately, there is hardly a selection of dividends ETF worldwide.

Using the search engine available on the justetf.com website, only 6 ETFs could be found for 5 dividend indices (as of March 2017), of which only 4 ETFs were found.

The financial services provider Morningstar published an analysis in 2015 that showed that, over the last three years, dividend ETFs across all categories have lagged behind the market capitalization-weighted indexes.

Particularly striking are the large differences in the results. Some dividend products performed exceptionally well while others were extremely bad.

The result shows that, in the end, each selection of stocks leads, in certain respects, to a portfolio that is better in some years and worse in some than the corresponding benchmark.

Another disadvantage is the fact that ETFs react slowly to foreseeable corporate crises, since there is no manager who removes the stock from the fund as a precaution. Dividend ETFs invest in a dividend until they are no longer.

Conclusion on dividend yield

Dividends are particularly popular with their simplicity. Everyone can understand it. They certainly have many advantages, which should not be denied them. Therefore, if you want to use dividends to finance daily life, you can build a stable, passive income stream.

Even if the nice and regular cash flow on the account statements at the dividend collector can provide for joy, and the search for promising dividend titbits promises fun and excitement, both of them only represent a good feeling that does not withstand reality.

Dividends have a useful psychological effect as they are regular „treats“for long-term strategies. One should, however, in no case be deceived by this short-term positive experience about the objective disadvantages.

To hit the market with a dividend strategy is quite unlikely and if at all possible only if you as a dividend collector take an increased risk. All too often, the dividend collector pays the distributed dividend by computationally from his own pocket.

If you do not want to leave the way, the most successful choice is to obtain an attractive overall return with the lowest possible risk, a globally diversified passively managed ETF portfolio..

Perhaps a better alternative than dividend strategies may be the investment in undervalued stocks though fundamental analysis.



Author Barbara De Maizière (Vevey, Schweiz)


We have picked some articles for you to read

dividend

Übersicht über Kapitalanlagen wie Immobilien und spekulative Kapitalanlagen wie Aktien oder Gold.

Noch unsere Großeltern sparten Ihr Geld in erster Linie im sprichwörtlichen Sparstrumpf und etwas später vielleicht noch auf einem Sparbuch an..Read more

dividend

Secret Why Funds Always Invest Their Money in Active Investment

Since the dawn of the International Stock Markets, investors have been trying to generate returns by investing in individual stocks, commodities or in Government Bonds.. Read more

dividend

11 Biggest Mistakes To Avoid When Making Capital Investment

Banks and Big Financial Institutions are always in the financial markets to provide capital or to invest their own capital.. Read more

dividend

How to Invest Your Money in Best Performing Investment Funds

Investment Funds are pooled or cooperative investment vehicles where all the money from all the individual investors is put together under the name of the Funds.. Read more

dividend

11 Most Important Concepts Of Behavioral Finance Theory

Behavioral finance is a famous field of the finance that suggests the theories based on psychology (psychology finance or behavioral economics) in order to explain the concept of stock market anomalies.. Read more

dividend

11 Habits Of Successful Investors - Strategic Asset Management

There is nothing trivial when it comes to accumulating wealth and investing especially if the investors are confused between desired results and avoiding the risk factors. Read more