Should You Buy High-Growth Dividend Funds?

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Should You Buy High-Growth Dividend Funds?

Previously, I analyzed the performance of some of the leading and largest actively managed mutual funds that focus on high-dividend strategies. Today, I’ll examine the strategy of investing in companies that have shown persistent growth in dividends.

But before doing so, it’s important to point out that a problem with dividend focused strategies is that because today only about one-third of stocks pay dividends, such a strategy is less diversified than strategies that focus on other well-known factors such as size, value, momentum, and profitability/quality. In addition, they can lead to concentration in sectors such as utilities, creating other risks (such as term risk). And, for taxable investors, dividends are less tax efficient than capital gains because you are taxed on the full amount of the dividend (instead of just the portion that is profit).

It is my practice to keep the list to a manageable number of funds, and to ensure that I examine long-term results through full economic cycles. I analyze the performance of funds over a 15-year period that ends December 31st, 2015. Furthermore, when there’s more than one share class of fund available, I will use the lowest-cost shares that were obtainable for the entire period.

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This methodology creates substantial survivorship bias in the data. This occurs because we are considering only funds that survived the full period, and roughly 7% of all mutual funds disappear each year. Thus, the results are not reflective of what investors in these strategies actually earned using actively managed funds – they are biased upward. It’s a particular concern in this case because there are only seven funds that used a rising-dividend strategy and survived the full 15-year period.

Keeping that bias in mind, the following table shows the performance data for the seven actively managed rising-dividend strategy funds that survived. It also compares those returns to the returns of comparable funds (based on Morningstar’s investment style categorization) from the leading provider of index funds, Vanguard, and a provider of passively managed structured-asset-class funds, Dimensional Fund Advisors (DFA). (Full disclosure: My Firm, Buckingham, recommends DFA funds in constructing client portfolios.) The returns data covers the 15-year period ending December 2015.

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DFA funds can be purchased through some 529 and 401(k) plans, but are generally only available through an advisor. An investor would incur fees from that advisor; those fees can vary greatly (in some cases they are very low) and cover the full range of financial planning services the advisor provides. Also, John Hancock recently introduced a series of ETFs that are managed through DFA (with expense ratios that differ from the DFA funds cited in this article). Investors can purchase those ETFs directly. Investors can directly purchase all Vanguard funds.

Dividend Strategy Funds

By Larry Swedroe, read the full article here.

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