Why You Should Invest for Dividends

As a bond maven I get that coupon income dominates total return. The same is true with equities, even more so, dividends have dominated stock market returns historically and are likely to continue dominating future returns.

We buy stocks because we think they will "go up" and we can sell them for a gain. But think about it. Stocks go up presumably because the business is worth more. A business is necessarily worth more if it has large and rising distributions of cash (dividends) to company owners (stockholders). Unless you subscribe to a vast greater-fool theory - wherein someone is always willing to pay you more than you paid for a stock regardless of its "worth" - the final buyer has to be buying with the expectation of holding it in perpetuity based on its intrinsic value. If you are holding a stock with little expectation of selling it , the biggest value it generates is the cash dividend you receive from it. In the daisy chain of buyers and sellers, it mostly comes down to cash!

The point of investing in stocks may be access to cash streams in the form of a dividend, but the reality is that throughout the history of the modern markets speculation in stocks has made up a significant portion and at times the majority of market activity - this is true currently. Viewing the stock market as a casino where you can come away a winner overnight has been an all to common fallacy to many investors. Its the same logic that leads people, otherwise rational, to habitually buy lottery tickets.

The mack daddy of value investing, Benjamin Graham, devotes the entire first chapter of "The Intelligent Investor" to differentiating between investing and speculating. For him, "an investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." Graham necessarily set the bar high,:" investment is serious business - everything else is speculation."

Dividends dominate the components of total return. Total return, in any given measurement period, is the combination of the income received in the form of a dividend plus the change in the asset value - the stock price movement - both divided by the starting asset value. Whether looking a data going back over the last 80 years or longer, about half the average annual return from from stocks (about 4.5 percent) comes directly from the dividend. The other half come from capital appreciation, a rise in the price of the stock. And what is the reason for the capital appreciation, or at least the lion's share of it? Increased dividend distributions! The market's aggregate dividend distribution has grown at a compound rate of 4.4 percent since 1926. That is, of the markets' total return of 9.7 percent since 1926, about 80 percent of it came from dividends. Basically stocks go up because dividends go up!

How do you invest for dividends? First, determine whether to do it yourself or pay a professional. A lot of basic research is available on the Internet and discount brokers provide decent research and the ability to buy and safekeep your securities at a modest cost. There are several good books you can use to educate yourself and help build a proper portfolio. With that said and only partly out of self-interest, do I earnestly recommend the latter course of action. As full-time managers of dividend focused products we have substantial human resources and technology at our disposal. This is no guaranty of making a lot of money but due to risk controls and systems put in place over the last several years the chances of losing money are low.

CBlakely  CFP, CTFA  06/2011

Sources: Manias, Panics and Crashes: A History of Financial Crises, The Intelligent Investor, Shiller database, Yale Univ. http://www.econ.yale.edu/shiller/data.htm

Useful Mutual Fund and Annuity Facts!

A study by Dalbar, a mutual fund research firm in Boston, found that in the 20 years ended December 2010,the average stock fund investor had annualized returns of 3.8 percent, compared with 9.1 percent for the Standard & Poor's 500-stock index. The average person would have been better off, much better off buying an index fund and holding it for 20 years. This again makes the case for professional management or at least index investing if you are a diy type. Why do we keep listening to Sam Waterston?

Why is it when questioned about retirement, nearly everyone prefers the certainty of guaranteed income, like a defined benefit plan, commonly referred to as a pension? But when offered the chance by buying an annuity, nearly everyone declines. Economists call this the "annuity puzzle." Using standard assumptions, economists have shown that buyers of annuities are assured more annual income for the rest of their lives, compared with those who self-manage their retirement assets. There is the term "self-manage" again. Professional advice is invaluable.
Buying an annuity can be scary, make a mistake and there is usually a large upfront penalty in the form of a surrender charge.There are psychological ramifications as well. Rather than view an annuity as insurance against living a very long life, they are viewed as a gamble, in which you have to live a certain number of years to break even. And they can be very expensive - guaranteed income for life, sounds like it should be an expensive option to me. Are they good or bad? Yes and no. It depends on your income needs and investment objectives and risk tolerance. Also, if you can, buy direct from the insurer, it's the least expensive way to purchase an annuity.

CBlakely CFP, CTFA   6/2011

sources: Dalbar, Richard Thaler - NYT