The Use And Abuse Of Dividend Strategies
August 24, 2015
by Robert J. Martorana
The quest for yield has led to high valuations for dividend stocks and boom times for equity income funds. The problem comes when investors use dividend strategies too aggressively or as a cure-all substitute for financial planning, asset allocation and risk management. But there are certain guidelines that have proven to deliver superior results when constructing a dividend portfolio.
The popularity of dividends is waning. Recent data for equity-income funds shows outflows and lagging fund performance. As interest rates rise and as the economic outlook becomes more conducive to growth, valuations are likely to come under further pressure.
I will look at the underlying justification for a dividend-based strategy and at how the most popular funds have performed recently. I will then discuss the criteria that investors should use to construct the best dividend-oriented portfolio.
I’m a fan of dividend stocks. In fact, I used them liberally for my mom’s retirement portfolio, since dividends make sense when growth is sluggish and bond yields are low.
But I recognize the limits of the strategy. This is not a message that everyone wants to hear:
I have come to learn that Dividend Growth investors, which have also been disparagingly referred to as Dividend Zealots, are among the most optimistic investors in the universe. And in many ways, perhaps the most misunderstood. Dividend Growth investors often state that they are not concerned with drops in the price of their stocks, but only that their dividends grow. For some reason, this offends certain people who apparently feel that this makes Dividend Growth investors arrogant and/or even ignorant.
What these detractors misunderstand in my judgment, is that the average Dividend Growth investor does not worry about short-term volatility because they do not intend to sell. Dividend Growth investors buy in order to hold quality dividend paying companies for the long run…”
Unfortunately, investors cannot ignore short-term volatility just because they “don’t intend to sell.” Life has a way of surprising us with events that suddenly require liquidity. A dividend investor could be a forced seller in a bear market, and these losses are never recovered.
The pros and cons of dividend strategies
The first table below summarizes the pros and cons of dividend strategies from an advisor’s perspective. Dividend strategies can be elegantly simple; they can be easy to design, execute and explain to clients. There is an active community of dividend investors who share resources, which are shown in the second table below.