Or, the ElLobo UFT (Unified Field Theory) of investing!

Over the last several weeks, we have taken a detailed look at a few important concepts as related to investing.  First there was a thread on the meaning of Total Return.  Then there were two postings I made concerning the use of a yield focused approach while accumulating.  Then there was this latest thread concerning the use of a yield focused approach during retirement (decumulating, as it were).  This final thread that I have planned will tie this all together.

It all starts with a simple equation I recently gave:

V1 = V0 +/- CG + (C + Y – W)                           (1)

This says that the value V1 of your portfolio at some time equals it’s value at some previous time V0, to which the capital change component of total return CG is either added to, or subtracted from.  Additionally, you have to add to V0 any contributions C you made to the portfolio during that time period, as well as the yield Y (dividends and interest received) received during that time period.  Finally, you have to subtract out the amount withdrawn W during the period of time.  I called this the conservation of cash equation!

I previously alluded to buy, hold, and sell conditions, again related to this equation, but nobody picked up on it.  Turns out that the real meat of my recent discussions is tied to this.

Accumulation:

During your accumulation phase, W is zero, since you are not taking cash out of your portfolio.  You contribute cash to it (from your salary income and, maybehaps, your company matches), so C is some value.  Depending on the investments your choose for your portfolio, it may have some yield Y.  At any rate, (C + Y – W) is some positive number.  That means you are net adding cash to your portfolio, which is the definition of accumulation!

This you do for the 40 years you typically spend in your accumulation phase.  During accumulation, the cash you add to your portfolio hopefully increases in value, due to the compounding effect.  You are a buy and hold investor, choosing which assets to invest in, and how much to put in each.  You sell at your convenience and profit, hopefully taking advantage of over and under valued investments.

At some point in time, you may stop contributing to your portfolio.  However, whatever yield is generated by your portfolio is treated exactly like new money going into it.  You are still a buy and hold investor.

Retirement (Decumulation):

You are still a buy and hold investor, at least until you start withdrawing from your portfolio, and will remain a buy and hold investor, at least as long as you withdraw less than the yield.  You continue to choose which assets to invest in, and how much to put in each, the cash coming from the yield that is not withdrawn, but reinvested.  You sell at your convenience and profit, hopefully taking advantage of over and under valued investments.

The important thing is that you do not have to change your investment style, or strategy, once you start your withdrawal.  That is, your 40 year history of buy/hold (strategic sell) can continue indefinitely!

If you withdraw more than the yield, you can still be successful.  The key is to continue to sell strategically.  That is, you avoid, as much as possible, being forced to sell assets in down markets.

Risks:

I’ve taken the time to start these threads based on previous threads related to investment risks.  I have had discussions with many of you on the nature of specific risks, questioning you on your understanding.  Let me say that ALL investment risk shows up in equation (1) above, in either of the two independent variables that you cannot control.  Those variables are the capital change component CG and the yield component Y of the total return of your portfolio.  And the only part of the CG component that you cannot control is share prices (fund NAVs).

The market controls share prices/NAVs, while individual companies control dividend and interest yields.  You control the amount of cash C added to your portfolio, as well as the amount of cash W withdrawn from it.  You also control the number of shares of each of your assets that you own.  Your success in both your accumulation and decumulation phases of your life will depend on your money (cash) management skills.

Whenever people talk about risks, they typically talk about share price/NAV volatility.  Indeed, this is the classical and traditional measure of risk.  Let me emphatically state that volatility is not a risk over long investment time periods, falling share prices over that long time period is the risk.  In fact, short term volatility can be used to your advantage, that is, to increase returns.  Specifically, a highly volatile share price/NAV whose average value is rising steadily over time is an ideal investment.  The reason has to do with strategic selling and buying of this asset, over time.  That is, sell on or near the maxima return, buy on or near the minima.

Capitalizing on volatility:

Let’s assume you hold a certain number of shares N0 of a mutual fund, each with a NAV of P0.  The equation above tells you that the value of that holding is N0 * P0, or V0.  Let’s now also assume that your investment ‘strategy’ is to maintain that value over time, specifically over a long period of time.

First, over time, this fund will generate a certain amount of money (the yield Y), given by the per share yield times the number of shares owned.  Assume you put that yield into a money market account, rather than re-investing it.

Over time, the value of that investment will vary as the fund NAV rises and falls (it’s volatility).  To capitalize on that volatility, assume you sell off 10% of the shares your own whenever NAVs rise 10%, and you buy 11% more shares whenever NAVs fall 10%.  If NAVs stay within 10%, you neither buy or sell, you simply ‘hold’ what you own, collecting yield.

If share prices continually rise over time, you end up realizing a 10% capital gain every time that gain goes above your window.  You will gradually own less and less shares, but each is worth more and more than your purchase NAV.  All the while, the value of that holding stays within +/-10% of V0.

If NAV volatility is greater than 10% but the long term NAV is steady, then you will gradually build up capital gains, always buying low, selling high.

You may ask how this strategy can be used to ‘grow’ your portfolio, especially during accumulation?  It’s quite simple.  You start with a single mutual fund, and all contributions and yield from it go into the fund, until the target amount V0 is reached.  You then take all yield as cash, along with any of the realized capital gains, and invest in a second fund (along with new contributions).  Reaching V0 for that second fund, go on to a third, then a fourth, and so on.

If you reach a manageable number of funds (20-25 is a good target), you can go back and double (or at least increase!) your target value V0, but I would suggest that you again sequentially increase your holdings.

Anyhow, most people ‘grow’ their portfolio vertically, that is, they hold a fund or two, contribute to each, and watch shares prices rise.  The type of growth I am describing here is more horizontal.  The difference is that you take advantage of NAV volatility, rather than simply living with it!

There are other advantages.  First, you portfolio stays essentially equally weighted.  That is, you hold equal amounts of money in each asset.  Next, by choosing funds from drastically different asset classes, you are certainly well diversified.  Also, the returns from each of these drastically different asset classes are probably NOT well correlated, even hopefully inversely correlated, so overall portfolio risks are reduced.

So, how do you choose asset classes (and funds/stocks to represent those classes?).  First, I would choose the highest yielding fund in each class.  Then I would choose the most volatile fund for each class!  Finally, I would start with the highest yielding fund and work down in yield, as I add funds to my portfolio.

Next, you would not have to limit yourself to open ended mutual funds.  Certainly CEFs can also be used.  Likewise, individual stocks and bonds could be used, but I would use them only after most of your 20-25 asset portfolio had been constructed.  That is, if an individual stock is the second asset you choose, that target amount V0 represents half of your portfolio, but if it’s the 25^th, it represents only 4% of your portfolio.  We’re talking risks now!

As to what that target amount should be, I suggest something in the neighborhood of 1-2 years of your contributions to your retirement portfolio.  That is, if your salary is $50,000/year, you contribute 8% to your 401k, and your company matches with 4%, your annual net contribution will be $6,000, so a good target amount for V0 would be $10,000.

Likewise, if you are using mutual funds, set your gain/loss window at 10%, or $1000.  Finally, if you are using CEFs or individual stocks, set your gain/loss window at the value of 100 shares.

As to suggestions for those 20-25 funds, here is my suggested list, in very rough order of purchase (after the first 4!):

1 – ADVDX

2 – IMSIX

3 – Vanguard’s 7% managed distribution fund

4 – VWEHX

5 – LV fund

6 – SV fund

7 – LG fund

8 – SG fund

9 – REIT fund

10 – Long Term Investment Grade bond fund

11 – Short Term Investment Grade bond fund

12 – World LV fund

13 – World SV fund

14 – World LG fund

15 – World SG fund

16 – World bond fund

17 – Emerging Markets equity/bond fund

18 – Convertible Securities Fund

19 – Preferred Stock fund

20 – Utility stock fund

21 – Financial Services fund

22 – Inflation Protected Securities fund

23 – BDC individual stock

24 – Canadian Energy Trust individual stock

25 – Tanker individual stock

I can't find much to fault, ElLobo, with your suggested strategy.  I only wish I'd had a more ordered accumulation phase to have taken advantage of such a strategy.

But, given my love of infrastructure master limited partnerships, I'm surprised they didn't make your 'top 25.'  Perhaps they didn't make your list because you were focused on a tax-advantaged situation?

They could be purchased, within your strategy, in a taxable account with very little tax effect (maybe 90% of distributions are tax-deferred) and the considerable yield utilized as you outlined to diversify and add or add to other classes.  Over the last several decades, as a group, they certainly have done as well as some of the other classes you listed and fit within your other criteria - very low correlation to total market, 18% or so total annual return of which, on average, about 7.5% has been cash distributions, great growth of distributions, hardly a ripple in that early decade upset, etc., blah, blah, blah.

OK, now you can get back to the theory.  I found it interesting you used a card-playing, gambling expression as your subject when your strategy seems like a very conservative approach.

Regards.

Cliff

Thanks for taking the time to put your thoughts together for us.

re Risk...

Why would falling share prices be a problem for an investor who is essentially getting all his Total Return from yield, skimming off his SWR, and reinvesting the leftovers toward additional shares? Isn't this what you attempt to do?

re Yields...

Yields are only partially under control of companies. Companies, and indirectly investors, can set the distribution/share but the market sets the price. Within a certain range and over a certain time frame the distribution/share can be adjusted so that the yield stays constant, a nice benefit for investors reinvesting the distributions. But if the market is behaving irrationally, especially to the upside, yields are going to drop. This can be a problem.

We've discussed how a fund like VDAIX, a dividend growth index fund, could have a "problem" in the future because the lure of growing dividends pumps up the share price such that investors may be disappointed in such a fund's income potential. Of course, selling greatly appreciated shares is a good thing.

re Volatility... 

Looking at downward volatility... 

One needs to distinguish between good and bad volatility: Good volatility is a price drop based on movement of the overall market, whereas bad volatility is movement based on a company.

Good volatility can provide a buying opportunity because the investor can be pretty sure the company is not the problem. Bad volatility is a price drop reflecting investor fears about earnings, credit, bankruptcy, etc. Purchases under these conditions could be considered a test of one's valuation abilities or a test of one's contrarianism.

I think prices generally aren't perfect, but when a company suffers a 50% drop when there's a bull market everywhere else you really have to wonder.

Good Luck, Ken.
 

Because you are seeking volatility (to exploit during a trading range or an upward trend), ETFs (exchange traded funds) strike me as superior choices to regular open ended mutual funds.

At least, so long as this is the only difference.

Have fun.

John Walter Russell 

"I can't find much to fault, ElLobo, with your suggested strategy.  I only wish I'd had a more ordered accumulation phase to have taken advantage of such a strategy."

I wish I knew, then, what I know now!

Actually, during accumulation, I had only a few funds available in my 401k.  It wasn't until I retired, and rolled it over to Vanguard, that I was able to build my current portfolio.  As you may know, 40% of my portfolio is in VWEHX, while the remaining 60% is split about equally into 20 different individual stocks, CEFs, and one equity fund, ADVDX.

The whole point of this exercise was to try to respond to helmut, Bill, Ken, and Mathguy2 regarding using portfolio yield as the basis for the construction of a portfolio, it's ongoing management, and the withdrawals taken from it during retirement.  Specificaly, people often have asked how such an approach differs from a 'total return' approach.

I've made statements that portfolio yield is safer than portfolio growth, regardless of how you define risks.  That by relying on yield for withdrawals guarantees that your portfolio lasts forever, and that the withdrawal has a good chance of keeping up with inflation as well.  And that one can use a yield focused approach to investing regardless of whether in accumulation or decumulation.  Yet people tend to not believe, simply because this all goes against traditional, and current, thought.

Enough of this.

"But, given my love of infrastructure master limited partnerships, I'm surprised they didn't make your 'top 25.'  Perhaps they didn't make your list because you were focused on a tax-advantaged situation?"

Actually, I wanted to show a yield focused strategy using mutual funds, rather than individual stocks.  Most who frequent this board, especially the newer, younger, people, have a well founded fear of stocks.  I wanted them to focus on the strategy, rather than the specific examples.

As I mentioned above, I hold 2 OEFs, 4 CEFs, 3 BDCs, 3 CANROYs, 3 tankers, 3 REITs, 1 financial, 1 tobacco, 1 coal.  All are in either a traditional or Roth IRA (I'm busy converting as much of my traditional to a Roth as I can as fast as I can!).  I have nothing in a taxable account.

It was better for us to use up all that we had there before touching our IRAs.  Whenever we DID have significant assets in a regular taxable account, all was in either MMA or CHC, which are MLPs.  In fact, if I did have any taxable money, I'd be back into either of these!

"I found it interesting you used a card-playing, gambling expression as your subject when your strategy seems like a very conservative approach."

I do consider my approach quite conservative, although most on this forum consider it quite risky, given that 60% of it is in individual stocks, and high yielders to boot!  As of this afternoon, the overall weighted yield of my portfolio is 9.68%, I actively use the capital gain capture strategy I described in this thread.

I thought Kenny Roger's song quite appropriate for my strategy.  I am quite selective in what I invest in.  I have chosen a few stinkers over the last 4 years (I retired in 2003), but recovered.  I actually DO intend to buy, and hold, forever each stock or fund that I invest in.  But the final 'key' to my strategy is to decide when to 'fold 'em' and walk/run away.

Whenever I initially buy a stock, or fund, I select it based first on it's yield, then a host of other 'quality' measures.  I think we have discussed this in the past.  Anyhow, I have a 'target' yield of 8% for the asset.  That is, I see no benefit in spending a whole lot of time trying to decide whether or not it makes sense to invest in a company that pays 3-4% dividend yield!  Such a yield is double the current market yield, but I do better.

I mentioned that the ideal stock for me would be one with an ever increasing share price, but one that was quite volatile.  But there is one other condition as well, and that is that the dividend also increased over time.  If that DOESN'T happen, as the share price increases over time, the percentage dividend yield will decrease as well.  It turns out that, at the point where the yield becomes half of what it was whenever I got in, I get out!  That is, I fold.  If I go in at 8% yield, I get out at 4%.  In at 10%, out at 5%, and so forth.

My reasoning is quite simple.  Even though the quality of the dividend probably didn't change, if I wouldn't buy the company at 4% or 5%, why would I continue to hold it?  Remember, I still hold my target amount in the stock, having harvested capital gains every 10% or so, on the way up to that low yield!  The net result is that, at that fold point, I will have realized a 100% return on that capital (or would that be 200%?), as well as all of the accumulated yield harvested while holding it.  It isn't that the particular stock became a stinker, it's just that I can do better, as I explained above.

Actually, this is the point where I walk away from the stock.  I usually run if the stock cuts, or eliminates, it's dividend.

"Why would falling share prices be a problem for an investor who is essentially getting all his Total Return from yield, skimming off his SWR, and reinvesting the leftovers toward additional shares? Isn't this what you attempt to do?"

Yes, this IS what I do.  As a result, share price volatility is NOT a risk for me.  It's actually an opportunity to capitalize and get a bit more return, in addition to the yield of my portfolio.

Volatility IS the major risk most often discussed around here.  I remember discussing volatility, and Sharpe's ratio, with you, regarding the risks associated with funds like VWEHX and IMSIX.  I remember discussing volatility risks with Bill, and getting quite deep into efficient markets and frontiers, rebalancing, FF3F, small/value premia, and so forth.  I remember discussing the relative riskiness of two stocks, XOM and NAT, with helmut.

I remember posting about the relative riskiness of yield versus growth (share price behavior).  I remember discussing the relative riskiness of 10% yield stocks compared to 2%, or zero yield, stocks.  All of these discussions were based on my view that volatility wasn't a risk that I was much interested in, let alone worry about.

But a lot of this fell on deaf ears, hence my threads.

"Yields are only partially under control of companies. Companies, and indirectly investors, can set the distribution/share but the market sets the price."

The dollar amount of the distribution is set by the company, not even indirectly by investors.  The market sets share prices.  The percentage yield is thus set by both the company and the market.

"Within a certain range and over a certain time frame the distribution/share can be adjusted so that the yield stays constant, a nice benefit for investors reinvesting the distributions."

I know of no company that tries to keep it's percentage yield constant, by varying the dollar amount of the dividend.  Also, there is no way the company can directly affect it's share price.

"We've discussed how a fund like VDAIX, a dividend growth index fund, could have a "problem" in the future because the lure of growing dividends pumps up the share price such that investors may be disappointed in such a fund's income potential. Of course, selling greatly appreciated shares is a good thing."

This is something that a yield focused investor isn't concerned with.  We care about the yield, and the quality of that dividend, period.  Share price behavior isn't important, unless one strategically buying and selling.  Put another way, I am more confident chasing yield than chasing growth!

Furthermore,

"One needs to distinguish between good and bad volatility: Good volatility is a price drop based on movement of the overall market, whereas bad volatility is movement based on a company."

Volatility is the SD of the return, and since the dollar amount of yield typically doesn't vary much (except tankers!), almost all TR SD is due to share price SD.  That is to say, share prices are much more volatile than dollar amounts of yield.

The SD of the TR of a company is a statistical characteristic of that companies historical share price behavior, regardless of the causes of that behavior.  As you well know, the TR of a company one year down the road has a 66% or so probability of being within 1 SD of it's historical long term average annual TR, 95% chance of being within 2 SDs of that average, 99% chance of 3 SDs, and so forth.

Nevertheless, I understand your point.  If the market, as a whole, lost 10% last year, then you might expect any stock that also lost 10% to suffer with all of the other drops of bathwater, regardless of the specific performance of the company.  But a company that fell 10% while the market was up 10% should be suspect.

I am a firm believer in evaluating each and every individual stock that I own on it's own merits, not on that of the market.  I"ve always called that an evaluation of the quality of the dividend.  As I've explained several times, I'll sort all individual stocks in the market by their individual yields, and select, as a first cut, all stocks with a dividend yield above 6%.  I then start at the one with the highest yield and evaluate each and every company, looking for reasons to NOT put money into it!

My first screens are the M* Financial Health and Profitability stock grades.  Idealy, both grades should be A.  I don't really care about the growth grade, since I am perfectly willing to collect, for example, a 10% yield from a company, rather than hope for a 10% growth in it's share price!

Anyhow, I won't go over all of the details again.  JWR calls my process 'due dilligence'.  At any rate, I eventually end up with a stock, CEF, OEF, MLP, fund (almost any type of asset) paying a yield (hopefully above my minimum 7% that I get with my junk bond fund).

Then I minimize my overall risk of investing in it by putting no more than, in my case, 3% of my portfolio into it!

The bottom line is that I think it much more fruitfull to look at assets in this manner than to try to figure out why a companies share price is doing what it's doing!  I'm much more interested in figuring out what a company will be doing with it's dividend.

JWR,

"Because you are seeking volatility (to exploit during a trading range or an upward trend), ETFs (exchange traded funds) strike me as superior choices to regular open ended mutual funds."

I'm not sure what an ETF would buy you.  I know what they are, and assume that their price at any point in time is reflective of the NAV of some corresponding OEF.  Perhaps I'm wrong.  I've never really looked at them in much detail.  Each time that I have, it seemed that their yields, although quite high by market measures, we're still quite low by mine.  That is, an ETF, such as DVY, might pay double the market yield, but 3.25% is still so far below what I target as not being something that I really spend time on.

Others may feel differently.

I think it much more critical to have all different asset classes represented in a portfolio, and choose the OEF, CEF, ETF, individual stock for that class that has the highest quality yield, and live with whatever volatility that tags along.  That is, this gain capture strategy is secondary to my main yield focused strategy.

In general, I've found that I may make only one or two 'gain capture' transactions on any one individual asset per year in my portfolio.

Usually, an ETF is more volatile than its corresponding index fund.

However, I am not sure that suitable index funds exist.

Have fun.

John Walter Russell 

Then I minimize my overall risk of investing in it by putting no more than, in my case, 3% of my portfolio into it!

Do you ever allow your "winners" to grow beyond 6%?

Unless your expected returns are similar, you may be limiting your upside.

OTOH, this does handle bankruptcy, fraud, accounting and related real world risks.

Have fun.

John Walter Russell 

re "Yields are only partially under control of companies. Companies, and indirectly investors, can set the distribution/share but the market sets the price."

The dollar amount of the distribution is set by the company, not even indirectly by investors.  The market sets share prices.  The percentage yield is thus set by both the company and the market.

I disagree that investors have no effect on dividends, why do you think corporate management has such a tough time declaring dividend cuts. And why do you think dividend cuts can cause such large price drops...the investors are selling and looking for better investments.

re "Within a certain range and over a certain time frame the distribution/share can be adjusted so that the yield stays constant, a nice benefit for investors reinvesting the distributions."

I know of no company that tries to keep it's percentage yield constant, by varying the dollar amount of the dividend.  Also, there is no way the company can directly affect it's share price.

You are missing the potential for increasing dividends, and how they provide constant value for investors who have no inclination to sell shares in order to realize gains. Companies can't directly affect their share price...try an earnings surprise!

re "We've discussed how a fund like VDAIX, a dividend growth index fund, could have a "problem" in the future because the lure of growing dividends pumps up the share price such that investors may be disappointed in such a fund's income potential. Of course, selling greatly appreciated shares is a good thing."

This is something that a yield focused investor isn't concerned with.  We care about the yield, and the quality of that dividend, period.  Share price behavior isn't important, unless one strategically buying and selling.  Put another way, I am more confident chasing yield than chasing growth!

What happens as the price of a stock goes up......the yield decreases. IOW, the dividend is more costly to investor; therefore, the investor is losing value.

How can you claim to be a yield investor when you say "We care about the yield, and the quality of that dividend, period.  Share price behavior isn't important,..." Share price is just as important as the dividend itself. When you pay too much for the dividend the future income stream is worth less to you.

Good Luck, Ken.

Thank you as  for a good post full of information and I agree on most of what you say about when to fold and when to hold, however I have some questions about your folding when your  yield is cut in half because of stock price appreciation. I assume you are talking about market yield as I see no way your yield could be cut except the company cuts their dividend. If you are talking about market yield and the company raises their dividend ever year is not your dividend going higher every year?

Lets drop the word yield for a min. and talk cash! Walmart takes cash, checks and credit cards only no yield so if XOM raises their dividend every year and every four or five years splits their shares and dividend rate and you have a pile of shares times their low dividend rate due to spliting shares are you not better off with the hand you can see that you are holding then to throw the cards on the table and take five new ones?

Hope I made sense!

Copie

Keep in mind that ElLobo uses the capital Y for the total income from yield, not the percentage yield.

Have fun.

John Walter Russell 

This time I made a better reference to ElLobo's work.

http://www.early-retirement-planning-insights.com/notes-11-23-2007.html

Have fun.

John Walter Russell 

JWR,

"Do you ever allow your "winners" to grow beyond 6%?

Unless your expected returns are similar, you may be limiting your upside."

In my personal portfolio, the answer is no.  All of my equity is individual stocks ('cept for ADVDX), and I own each one specifically for it's yield.  That is, I prefer to harvest 10-12% yield rather than work for 10-12% capital gain.  So any gains that I DO realize are extra.

Now, if those gains (for an individual stock) come about through growth in dividends, the percentage yield should stay roughly constant.  If dividends do NOT grow, then share price appreciation leads to percentage yield decreases.  THIS is the case where I 'fold 'em'.

If I were to own an individual stock (or a fund) for share price/NAV growth, I would let it ride, harvesting those 10% increases.  That is, I would hold (in my example) $10,000 in a growth fund, and take out $1000 every time the NAV rose 10%.

Thanks for asking the question.  I've been thinking like a high yield individual stock investor for so long I forget what it was like before!

Copie, 

"I have some questions about your folding when your  yield is cut in half because of stock price appreciation."

If a company pays a constant dollar amount of dividend/yield every quarter, that is, there is no growth in the dividend, then it's percentage yield is cut in half whenever the share price doubles.  So, if I bought the stock because it paid a 10% yield, and the share price doubles such that it's percentage yield is cut to 5%, I'll fold.  I've at least doubled my money in this stock (plus the yield I collected while I held it).

So, if I wouldn't buy the stock if it paid a 5% yield, I won't hold it at 5%.  I'll fold and buy another individual stock that pays 10%.

Now, if the share price increases enough from year to year, and that is in response to an increase in the dollar amount of the dividend (like XOM), then the percentage yield should not be cut in half (with a doubling of the share price.  In my example, if the company pays a $1 dividend at a share price of $10, it's a 10% yield.  If it doubles it's dividend, and the market responds to that increase by doubling it's share price, it will now pay a $2 dividend at a share price of $20, which is still a 10% yield.

Ken,

"I disagree that investors have no effect on dividends, why do you think corporate management has such a tough time declaring dividend cuts. And why do you think dividend cuts can cause such large price drops...the investors are selling and looking for better investments."

"You are missing the potential for increasing dividends, and how they provide constant value for investors who have no inclination to sell shares in order to realize gains. Companies can't directly affect their share price...try an earnings surprise!"

You're missing the point that share prices are not DIRECTLY set by companies, nor are dividends DIRECTLY set by the market.  The company sets dividend amounts based on earnings (primarily), as well as a slew of other financial information.  The market regurgitates that same information and sets share prices.

"Share price is just as important as the dividend itself. When you pay too much for the dividend the future income stream is worth less to you."

If a company pays a $1 dividend, I'll buy that company at a share price of $10, but not at $20.  That is, I'll buy a 10% yield stock, but not a 5% yielder, and I'll bail out if share prices rise enough such that the yield, initially at 10%, falls to 5%.  Even though the dollar amount of the dividend doesn't change.

This is why I consider a 10% dividend yield company less risky than a 5% yield company.  We've argued this in the past.  Any given company that pays 5% has a much greater chance of seeing it's share price FALL by half, raising it's yield to 10%, then to see it's share price rise, and yield fall to 2.5%.

Whenever I say I don't care what share prices do, I simply mean that my investment strategy, for accumulation or decumulation, is based primarily on yield.  I always withdraw less than the yield of my portfolio (in dollars), so I am always reinvesting the excess yield.  So my withdrawals do NOT depend on selling shares.

Having my withdrawals always covered by yield means that I don't really care what the actual VALUE of my portfolio does, over time.  That value rises, and falls, as does everyone else's portfolio.

The fact that I do buy and sell shares, as I described in this thread, simply means that I use share price volatility to my advantage, and it's NOT a risk to me!

People often ask what it means to be a yield focused investor, rather than a total return focused investor.  They will talk about the total return of their portfolio, and how they withdraw less than the TR, but then can't answer what happens in the case where TR is negative!

For those who are NOT yield focused, I usually ask what kind of retirement withdrawal strategy they use.  Invariably, it's the Ad Hoc approach I described in previous threads.

Because if they say they use the Income Certain approach (constant real inflation adjusted amount of withdrawal), I ask how long they expect their portfolio (and income) to last.  Whatever they respond, I ask what will they do if they see they are running out of money before life, and they say they will stop withdawing.  And that's Ad Hoc.

Very few people, other than a yield focused investor, ever say they use a Period Certain strategy.

I had dividend growth in mind.

Consider the rapid growth of the JNJ dividend amount. Might it make sense to allow that dividend growth to continue beyond 10% (ignoring price changes).

Have fun.

John Walter Russell 

re

Because if they say they use the Income Certain approach (constant real inflation adjusted amount of withdrawal), I ask how long they expect their portfolio (and income) to last.  Whatever they respond, I ask what will they do if they see they are running out of money before life, and they say they will stop withdawing.  And that's Ad Hoc.

Very few people, other than a yield focused investor, ever say they use a Period Certain strategy.

Two reasons investors/retirees may be uncomfortable with Period Certain:

1) it forces them to confront their own demise

2) it may force them to lower their standard of living starting on the day they retire.

The actual investment style, ie yield-focused or growth-only, has nothing to do with choosing Income Certain or Period Certain. A growth-only only investor could use Period Certain and a yield-focused investor could use Income Certain. It boils down to portfolio size upon entering retirement, periodic expenses, return expectations, life expectancy, and a number of other variables.

However, I think tilting toward yield can improve the odds of success regardless of whether the Income Certain or Period Certain approach is selected. A question is whether strategies that get 100% of their TR from either yield or growth are wise?

Good Luck, Ken.

However, I think tilting toward yield can improve the odds of success regardless of whether the Income Certain or Period Certain approach is selected. A question is whether strategies that get 100% of their TR from either yield or growth are wise?

Then why does El Lobo need to sell stocks?  Or why does the thread explain why a yield focused investor is not taking 100% of his TR from yield?

Roberta 

Hi Roberta,

Not sure if I'm following you.

re my statement:

However, I think tilting toward yield can improve the odds of success regardless of whether the Income Certain or Period Certain approach is selected.

What I was trying to say, indirectly, was given the market's current yield I think investors almost have to tilt (mostly toward LV) in order to get a reasonable split between the TR components of growth and income...I think accepting a yield of about 1.5% and claiming to be a TR investor are contradictory.

re

A question is whether strategies that get 100% of their TR from either yield or growth are wise?

EL can use the Period Certain approach because theoretically he never has to worry about dipping into principal, he lives off the big yield and probably is even able to reinvest some of it towards fighting inflation. As long as the yield is sufficient to pay the bills, he's set...almost. Is he taking on a lot of risk for that high yield?

Hopefully, being more specific helps.

Good Luck, Ken. 

"I think accepting a yield of about 1.5% and claiming to be a TR investor are contradictory."

If you accept market, or below market, yields of 1.5%, you ARE a growth focused investor, rather than a yield focused one, because you are expecting 6% to 8.5% growth in share prices/fund NAVs. 

"because theoretically he never has to worry about dipping into principal"

The only 'theory' to contradict this fact is that dividends somehow are a return of principle.

"Is he taking on a lot of risk for that high yield?"

I don't think so.  If I expect ALL stocks to return 10%, I believe it much more risky to invest in a stock, or fund, with zero yield, expecting 10% share price/fund NAV growth, rather than a stock, or fund, yielding 10%, expecting zero growth!

Ken, Roberta understands that ALL of investing is divided into two parts - choosing your investments is the first, managing your money (purchasing, holding, selling) those investments is the second.  How you do the second is, IMO, highly dependent on your focus for the first.

"A question is whether strategies that get 100% of their TR from either yield or growth are wise?"

The way I look at it, it's the company, through dividend distributions, that provides the yield of an investment.  It's the market that provides the growth.  I prefer to trust corporate management, rather than the market.  It's known as the greater/lesser fool theory.

First let me thank you for your post. I have read it several times with great interest. I find your post very thought provoking.   There are certain things I can agree with, but there are also several areas where we have a disconnect.

I do understand your concept of diversifying away risk by limiting the amount of your investments, but I also see a point of diminishing returns to your diversifying strategy.

 I can see having twenty or twenty-five individual stocks, but it seams to me having 23 mutual funds and three individual stocks would insipidly water down your portfolio to pabulum. I can also see an opportunity for considerable overlap with your marketing strategy. What stock could ADVDX hold that would not be represented in the other 22 mutual funds you listed?

Your theory's need to put so much inference on diversity  and channeling tells me you are not secure in the ability of your high yield investments to compete profitably and independently over the long term.

If and when I decide to invest in individual stocks, I would invest, as a business owner would, in companies with growing cash flow, great management, strong and consistent dividend growth, and a dominate market advantage purchased at the right value.

Investing in large businesses with strong balance sheets and dominate market positions provide much more diversity than smaller business using high dividend payout ratios to attract investors, thus lowering risk considerably, and making the need for both extreme high yields and extreme diversity less important. Which offers an investor more diversity and stronger financials, NAT or XOM?

 I consider Mutual funds as just holding companies and try to hold mutual fund to the same standards as much as possible.

 As the old saying goes I would not invest in a company for a minute unless I was willing to own that company for 20 years. I have no problem with buying stocks that are under valued, then selling when the stock becomes overvalued; I just believe an investor can be more successful doing it with better companies rather than companies with higher yields.

From all the evidence that I have seen, period certain withdrawal strategies with the type stocks I have just outlined, have done extremely well without the need for extreme dividend yields.

"A question is whether strategies that get 100% of their TR from either yield or growth are wise?"

Your answer,

The way I look at it, it's the company, through dividend distributions, that provides the yield of an investment.  It's the market that provides the growth.  I prefer to trust corporate management, rather than the market.  It's known as the greater/lesser fool theory.

 Your statement is a gross misrepresentation. The greater/lesser fool theory normally refers to momentum investing of stocks that are extremely overvalued as was the case with high tech and internet stocks in the late nineties. Companies with good management, profitable business plans and consistent dividend growth did just fine during the last correction.

In the short term the market may penalize a company's share price, or may award it unrealistic value, but in the long term revision to the means is just the market correcting itself.

Financially profitable companies should not fear the market, because the market will eventually recognize earnings and profitability, but on the other hand your inability to produce any substantial long term evidence to back your extreme yield theory up still leads me to the conclusion there is a good reason to believe it does not exist.

helmut 

Financially profitable companies should not fear the market, because the market will eventually recognize earnings and profitability, but on the other hand your inability to produce any substantial long term evidence to back your extreme yield theory up still leads me to the conclusion there is a good reason to believe it does not exist.

Interesting.

Using your criteria: History repeatedly shows that the alternative fails. 

The market reaches sky high valuations and then performs badly for a decade. Yes, allow a couple of decades and these companies will be discovered once again.

Have fun.

John Walter Russell 

JWR1945a:

Financially profitable companies should not fear the market, because the market will eventually recognize earnings and profitability, but on the other hand your inability to produce any substantial long term evidence to back your extreme yield theory up still leads me to the conclusion there is a good reason to believe it does not exist.

 

Interesting.

 

Using your criteria: History repeatedly shows that the alternative fails. 

 

The market reaches sky high valuations and then performs badly for a decade. Yes, allow a couple of decades and these companies will be discovered once again.

 

Have fun.

 

John Walter Russell 

What is really interesting John is that I have never seen you use my criteria in any of your post. What I have seen is your repeated use of indexes (S&P 500) to substantiate your positions which has very little relevance in this discussion.

helmut 

Some people complain that the S&P500 is really nothing more than a handful of large capitalization stocks. Others say that it is the market.

I have looked at slices (large, small; value, growth) via "Gummy Slices" and I have looked at dividend quintiles. They all tell the same story. Yet, that is never good enough.

Data that I do not have must be better. 

Have fun.

John Walter Russell 

John..... Remember these numbers from Mathguy2? 

It looks like this is like this is supposed to be more of an algebraic analysis, but I thought this data would be helpful. It is the 1927-2006 FF data by dividend yield deciles. I have four portfolios -- Total Stock Market (TSM), Large Cap (Lg) which is close to the S&P 500, Highest 30% Dividend Yield stocks (D30), and Highest 10% Dividend Yield stocks (D10). I looked at 30-year retirement periods beginning in the year shown with [actual historical] inflation-adjusted withdrawals. Portfolios are 100% invested in stocks and any dividends in excess of the year's withdrawal are reinvested in stocks. Column Y is the initial portfolio yield. Column WR is the maxmum withdrawal rate that will not completely liquidate the portfolio within 30 years.

The data is much easier to digest if you cut and paste it into Excel and create a x-y scatterplot of initial yield vs max withdrawal rate. Use a separate data series for each portfolio and draw a straight line from the origin to the 16%/16% point in the upper right corner. Here is what I found interesting:

1) The dividend portfolios have significantly higher average WR than the "index" portfolios -- 9.13% and 8.46% for D30 and D10 versus 7.52% and 7.16% for TSM and Lg. The lowest WR is a little under 4% for all the portfolios.

2) Using the initial portfolio yield to gauge a successful 30-year withdrawal rate works 98% of the time for the "index" portfolios, 90% of the time for the D30 portfolio, but only 56% of the time for the high yield D10 portfolio.

EL,

A couple of points of contention or discussion.

" Any given company that pays 5% has a much greater chance of seeing it's share price FALL by half, raising it's yield to 10%, then to see it's share price rise, and yield fall to 2.5%."

Unless you are talking about a certain context, like stocks that have a mean yield of 10%, this is pure horsefeathers.

We can find many examples of financial stocks that may be reaching the 5% yield today because of depressed prices, and will surely revert to 2.5-3% in the future, not keep going to 10%.

While I think I understand where you are coming from here, the mean dividend yield over a long period seems to me to be a place to start your analysis of whether the dividend yield is likely to rise or fall.

"The only 'theory' to contradict this fact is that dividends somehow are a return of principle."

You and I have discussed this and I have yet to receive an explanation from you that makes sense.

To review:  I posited that stocks had to rise in price over time in order for the dividend not to be a return of principal.  The reasoning is simple.  The stock price always falls very close to the same amount as the dividend.  You have never disagreed  with this.  Unless the price has risen to compensate for that, you are just being given part of your stock price (principal) as a distribution and have gained nothing.

You said you never heard of the theory that stocks raise in price prior to a distribution.  But then you provided no cogent explanation for how dividends actually add value.

So I'm asking you again, if I'm to become a dividend focused investor, I need to understand what I'm getting and from where.  Spending $10 and having $1 handed back to me later and having $9 left does not seem like gaining anything to me.

I know that stock prices rising in anticipation of a dividend doesn't jibe with you point that "prices are irrelevant to a yield focused investor", but if prices don't rise, than please tell be in a simple explanation without formulas where the value comes from?

Anyone else who can clear this up, please jump in.

best,

Bill

helmut,

"If and when I decide to invest in individual stocks, I would invest, as a business owner would, in companies with growing cash flow, great management, strong and consistent dividend growth, and a dominate market advantage purchased at the right value."

Tell me, why do you feel high yield companies do NOT have these attributes, while low, or zero, yield companies DO have these attributes?  This is the crux of our disagreement. Put another way, could you simply explain why you feel high dividend yield companies are riskier than low yield companies?

"Your statement is a gross misrepresentation."

I don't know how many different ways to say that it's safer to rely on the company generated portion of total return (yield) than on the market generated portion (share price growth).  Put another way, if you disagree, could you simply explain why you feel market based returns are less risky than company based returns?

"substantial long term evidence to back your extreme yield theory up still leads me to the conclusion there is a good reason to believe it does not exist."

Well, I'm not sure why you call it a theory?  If I tell you I have all of my money in a savings account at my local bank, and that the rate of interest today is 3%, then my 'theory' says that I can spend that yield indefinately, and never touch principal.  If I spend 4%, I do touch principle, and eventually my bank balance goes to zero.  If I spend 2%, then I grow principle.

I guess if you want to call that a theory, go ahead.  If you don't believe it to be true, again that's fine with me.  Put another way, under what conditions would someone touch/spend principle if they are spending less than their yield?

My own research centered around quartiles. Refer to Current Research K: Dividend Slices at my website.

http://www.early-retirement-planning-insights.com/current-research-k.html

Using deciles may be too tight. Also, David Dreman's research shows that the highest dividend is not necessarily the best.

I used the percentage earnings yield 100E10/P where P/E10 is Professor Shiller's P/E10.

I calculated regression equations and determined the relationship between 100E10/P and Historical Surviving Withdrawal Rates. I include confidence limits (90% two sided)

.

(I am never comfortable with any claimed precision greater than 90%.)

I rely on the regression equation and confidence limits, not the data extremes. 

Have fun.

John Walter Russell 

Your conformation bias tendency to give more attention and weight to data that support your beliefs than to contrary data is especially unreasonable when your beliefs are little more than prejudices.

 If your beliefs are firmly established on solid evidence and valid confirmatory experiments, the tendency to give more attention and weight to data that fit with your beliefs should not lead you astray as a rule, but if you become blinded to evidence truly refuting a favored hypothesis you have crossed the line from reasonableness to closed-mindedness.

helmut 

Bill,

"this is pure horsefeathers."

"While I think I understand where you are coming from here, the mean dividend yield over a long period seems to me to be a place to start your analysis of whether the dividend yield is likely to rise or fall."

Think of it this way.  The percentage yield varies inversly with share price.  That is, as prices rise, yields fall, as prices fall, yields rise.  I simply use percentage yield to determine when to 'buy low, sell high', only it works inversly, that is, 'buy high (yield), sell low (yield)'.  Absent no other information about the company, high yield implies undervaluation, which low yield implies overvaluation.

I think of D/P (percentage yield), and it's inverse P/D (Price to Dividend Ratio) as equivalent, for valuation purposes, as P/Es.  But then that's just me!

In my screening for stocks to invest in, whenever I look, in detail, at a high yielder, I look at it's share price history, in Yahoo!  This indicates to me not only the consistency of that dividend (making sure a 10% yielder wasn't a one-time distribution, for example), it also shows me where that stock is in it's normal volatility cycle.

This is really a judgement call on my part.  If I see a 10% yield at the high point of a volatility cycle, I'll expect the share price to swing downward at some time in the near future, and it's dividend yield to increase as a result.  If I see it's at the low end of it's cycle, I'll consider it undervalued, and jump in.

Anyhow, to answer your question, my 'examples' of a stock that yields between 6% and 12%, or 5% and 10%, had 'average' yields midway between the extremes, or 9% and 7.5%.

"The stock price always falls very close to the same amount as the dividend."

The ONLY prices that fall (exactly by the amount of the dividend) on the ex-div date are the buy and sell limit prices on the order books of the marketmaker for the stock on the exchange.

"But then you provided no cogent explanation for how dividends actually add value."

I don't understand.  Add value to WHAT?  Perhaps, if you mean portfolio value, then reinvestment of dividends (buying more shares) adds principle, adds value to a portfolio, while spending dividends doesn't add value, but it doesn't take it away either!  Value is taken away by selling shares and spending the proceeds.  Changes in value imply neither the addition of principle to a portfolio, nor the taking away of principle.

Maybe we disagree what we each mean by 'principle', 'capital', and 'yield'.  I remember the first equation I learned in school (4th grade) - The amount of interest earned equals the principle amount multiplied by the rate of interest, then multiplied by the amount of time.  That is, I = P * r * t.  Put $1000 into the bank, at 3% per year interest, and you earn $30 of interest over one year.

If you spend that $30, you still have $1000 left in the bank.  If you spend $50, you only have $980 left.  With this, my 'principle', or 'capital', is $1000, my 'yield' is either (actually, both!) 3% or $30.

If I apply this to stocks, my 'principle' is the amount of money I put into the stock, on day 1.  The principle value of that holding changes as share prices change.  At some point in time, the company pays a dividend, which will be a certain dollar amount per share.  Dividing that dollar amount by the share price converts from dollars to percentage.

Given that the dollar amount of regular dividends is usually dwarfed by normal share price fluctuations of stocks, are you really bothered by this philosophical difference that we have?  That is, if a dividend really were a return of principle, or capital, would it make any difference as to how you perceive yield focused investing, either individual stocks or funds?

My answer to the above question is that it really doesn't matter to me where it is a return of principle, or not.  Dividends are what they are, share price are what they are, and dividends are much more stable and predictable than share prices.

Try as I have, I just can't logically grasp your reasoning on this.  It would help if you explain, in simple terms as I have done above, how you really define principle and yield!

I'm thinking perhaps you are equating earnings and dividends, that earnings add to corporate cash/assets.  If so, then perhaps you then equate cash/assets to principle.  If so, then spending a part of earnings is spending principle.  But then share prices are not directly tied to earnings, although earnings are the primary driver for share prices.

That is, share prices don't automatically go up $1/share if the company earns $1/share.  Likewise, share prices are not tied directly to book value (cash/assets), so spending a buck of cash/assets doesn't automatically lead to a reduction of share prices.

Anyhow, enough said.

Margaret,

"Harvest the increases that are over the NAV of what i originally bought. Ok, this one will take discipline, but i totally agree w/ it. I think i will not do this until i retire."

That's where the target amounts come in.  That is, if you hold, say, $10,000 in a fund, or a stocks, you can watch the value of that holding over time.  If the value gets to your trigger point (a $1,000 increase, or a value of $11,000), you sell off enough shares to bring the value back down to $10,000.

You set these trigger points according to your own style.  In fact, if you are dealing with individual stocks, you can put in a limit sell order at the trigger share price.

One thing you might pick up from this thread is that it works well regardless of whether you are accumulating or decumulating.  As you build up your 25 fund portfolio, all capital gains that you harvest from the funds that are fully funded ($10,000) go into the next one that you are working on, which will be the one that current contributions are going into.

Then, if normal volatility takes the value of one of your funds down to $9,000, contribute to it until it is back up to $10,000.

All of your fund/individual stocks will have decent yields, and all collected yield goes into the next fund/stock on your list.

What I am suggesting is that you go back to my original posting on this thread and work through the buildup of the portfolio, starting from square one.

El,

First, out of all those paragraphs of information, only this one sentence even came close to an answer with no explanation:

"The ONLY prices that fall (exactly by the amount of the dividend) on the ex-div date are the buy and sell limit prices on the order books of the marketmaker for the stock on the exchange."

Please understand, I am not trying to extend this discussion for fun but I really don't understand that point, (likely because I don't buy individual stocks)

It seems to me that you are saying that unless you have a buy or sell limit order in on the ex-dividend date, that the price of your stock doesn't fall after a distribution.  If that is what you are saying, and assuming the share price stays completely flat due to market forces, when can you expect to sell your stock if you wanted to at the PRE-DISTRIBUTION PRICE?  A week?  A month? Can you provide a source for this concept where I can read a detailed explanation?  That might help clear it up for me:)

And why does the price drop only for limit orders but not for everyone else?

My understanding is different.  It is that the price drops across the board for all holders of the stock who are entitled to the dividend.  The reason is, in my understanding, that the dividend distribution removes a specific amount of value from the company, value that was there on the day before, but has been given away on the day after.  The share price has to fall to reflect this, or else everyone would buy the stock at the last minute, and sell for the same price after receiving the dividend, thus getting a free lunch.

Now on to your question about principal and yield.  My definitions are the same as yours, except perhaps, I believe that principal is the amount you have at any given time in a portfolio.

If I assumed that principal was only the amount invested, rather than the portfolio value, then my principal would be only the sum of all those IRA and 401K payments made over the years, not the earnings.  If that was the case, then my principal might be only 40% of my total portfolio value after 30 years of investing. 

When a retiree says he wants to invest to protect his principal, do you think he means that he is willing to lose 60% of his nest egg or do you think he is saying "I want to keep what I have now".  I think the latter and my principal is the worth of my portfolio on January 1 of each year and I compare it to December 31 of the same year, and any positive return is gain for a day or two, and then on January 2, it all becomes principal again. 

"Given that the dollar amount of regular dividends is usually dwarfed by normal share price fluctuations of stocks, are you really bothered by this philosophical difference that we have?  That is, if a dividend really were a return of principle, or capital, would it make any difference as to how you perceive yield focused investing, either individual stocks or funds?"

Are you serious?  Of course it makes a difference!  If you are just getting your money back, then you are getting NO VALUE from a dividend.  You have $10, they give you one back and you now have 9+1=$10.

I DON'T BELIEVE THAT DIVIDENDS ARE RETURN OF PRINCIPAL.  I NEVER SAID THEY WERE (in general, with the exception of special dividends in some cases)

My point was very simple and somehow you have attributed far too much thinking and philosophy on my part to it.

1.  Stock prices fall after a dividend by the amount of the dividend
2.  Unless stock prices have risen over time the amount of the dividend (+ or - any market driven price changes), then you are being handed back money today, that you already had yesterday.  Your total worth is the same on both days.  If you take the distribution in cash, you are taking "principal".  You are just splitting you money into two different pots. 
3. However, if as I believe, the stock price does rise over time the amount of the dividend, then you are being hand back that gain, rather than your principal on Jan 1.

best,

Bill

El Lobo,

Tell me, why do you feel high yield companies do NOT have these attributes, while low, or zero, yield companies DO have these attributes?  This is the crux of our disagreement. Put another way, could you simply explain why you feel high dividend yield companies are riskier than low yield companies?

First and most obvious I'm not talking about zero yield companies. Secondly I'm not saying that there are no higher yielding companies with these attributes. I just do not believe that higher yields are in and by themselves a barometer of a SWR.

When you limit yourself to higher yielding stocks you shrink your investment universe and miss the PG's, JNJ's, XOM's and the 3M's of the world just because you're afraid of selling shares.

Yes I believe you probably can find a high yielding company that has the attributes I alluded to, I also believe you can probably find companies that pay no dividend that have those attributes too. I also believe that occasionally you find a good biscuit in the garbage can too, but I'm not going there for breakfast. The bottom line is that you have never provided any valid confirmatory evidence that extreme yields raise the SWR, and until you do, you are just whistling in the dark.

I don't know how many different ways to say that it's safer to rely on the company generated portion of total return (yield) than on the market generated portion (share price growth).  Put another way, if you disagree, could you simply explain why you feel market based returns are less risky than company based returns?

Telling is not selling. You can repeat yourself as many times as you want, the actual facts do not support your position. A hundred years of history should be able to provide you with more evidence than you have been willing to provide.

Well, I'm not sure why you call it a theory?  If I tell you I have all of my money in a savings account at my local bank, and that the rate of interest today is 3%, then my 'theory' says that I can spend that yield indefinitely, and never touch principal.  If I spend 4%, I do touch principle, and eventually my bank balance goes to zero.  If I spend 2%, then I grow principle.

Is this what you call confirmatory evidence? El Lobo, I read almost every one of you post. I think your post really stimulate thought and  in turn enhance the learning process, but don't just make a frivolous statement then dare me not to believe you.

helmut

Your conformation bias tendency to give more attention and weight to data that support your beliefs than to contrary data is especially unreasonable when your beliefs are little more than prejudices....

If this were true, you would have a point.

Now move the double edged sword in the other direction. 

John Walter Russell 

"Stock prices fall after a dividend by the amount of the dividend."

Bill, there's a difference between the valuation of NAV for a fund upon a distribution and the real-world action of stock prices for individual companies that pay dividends.

As an small experiment, why don't you pick a dividend paying stock (any one will do) and go to its most recent dividend (or, any one will do).  Check the closing price on the day before and the day after the value of the dividend transferred from the company to the stock owner.  (Also, check the price action during the day and the posted open price.)

Regards.

Cliff

re I don't know how many different ways to say that it's safer to rely on the company generated portion of total return (yield) than on the market generated portion (share price growth).  Put another way, if you disagree, could you simply explain why you feel market based returns are less risky than company based returns?

I guess this sums up your rationale for investing such that you get as much of your Total Return from income as possible.

There is no such thing as company generated return, returns come from earnings/FCF and market speculation. E/FCF can be used 2 ways: Reinvestment into the company toward future growth and/or distributed to shareholders in the form of a dividend. All speculation does is move the share price.

You consistently imply that growth (NAV appreciation) is due to speculation, which is not true. Over the long term speculation has little effect, unless one is the greatest market timer or the greatest value investor or the greatest momentum investor. For us forum posters speculation does nothing for our portfolio value over the long term.

So that leaves us with reinvested E/FCF and dividends. We all know about dividends, so we're really left with reinvested E/FCF.

Reinvestment is required to keep pace with inflation, build new facilities, purchase the latest widgets that improve efficiency, conduct R&D, etc. Do you really believe a company that is not doing these things with E/FCF is less risky because it's paying out everything to shareholders? It's a dead-end investment, in fact it's really short term speculation in the sense that you're gambling to get back more in dividends than what you invested...knowing full well there's no future. 

You are making a mistake failing to distinguish NAV growth due to speculation from NAV growth due to underlying earnings. Both are reflected in the share price, but one is temporary and the other is pseudo-permanent. I guess this is what drives you to the other extreme, ie high yield, which I view as risky because you're investing in companies with little growth potential for the sake of yield. Once again, high yield can be viewed as bribery. 

You consistently imply that growth (NAV appreciation) is due to speculation, which is not true. Over the long term speculation has little effect, unless one is the greatest market timer or the greatest value investor or the greatest momentum investor. For us forum posters speculation does nothing for our portfolio value over the long term.

People live in the short term. We need to eat every day. We need to withdraw funds every year or so.

The long run is 30 years. Even 10 years does not reduce the effect of speculation.

[Actually, the dollar effects remain. Only the annualized percentage variation is reduced. There is An Illusion of Numbers.]

Retirement portfolios go bust because of short term fluctuations.

Have fun.

John Walter Russell
 

An Illusion of Numbers
 

http://www.early-retirement-planning-insights.com/illusion.html

Have fun.

John Walter Russell 

JWR,

Investing has been recognized as being contrary to human nature. 

We generally can't profit from relatively short term phenomenon (like the value premium) but our funds/managers can do it for us.

Cliff:

SO paid a .403 dividend on Nov 1.  Its closing price on Oct 31 was 36.66 and its opening price on Nov 1 was 36.16 or $.50 decline, $.40 of which was due to the distribution.

SO paid the same .403 on Aug 2.  Its closing price on Aug 1 was 34.91 and its opening price on Aug 2 was 34.22 or a $.69 decline, $.40 of which was due to the distribution.

Are you suggesting that individual stock prices don't fall pretty much in line with the dividend distribution?  I am aware the it is not exact like a MF, but pretty close and closer now that the tax on dividends has been reduced to the same rate as LT capital gains.

Maybe you can give me your opinion on how you receive value when a company pays you a dividend?  Lets say your stock is selling for $100 and you receive a $5 dividend.  The price is now around $95.  Where is the value to you derived?

All I have been saying is that unless the stock over some period of time rose $5 in anticipation of this future dividend, then how have you gained anything different then just selling $5 worth of shares?

best,

Bill

bilperk:

Cliff:

SO paid a .403 dividend on Nov 1.  Its closing price on Oct 31 was 36.66 and its opening price on Nov 1 was 36.16 or $.50 decline, $.40 of which was due to the distribution.

SO paid the same .403 on Aug 2.  Its closing price on Aug 1 was 34.91 and its opening price on Aug 2 was 34.22 or a $.69 decline, $.40 of which was due to the distribution.

Are you suggesting that individual stock prices don't fall pretty much in line with the dividend distribution?  I am aware the it is not exact like a MF, but pretty close and closer now that the tax on dividends has been reduced to the same rate as LT capital gains.

Maybe you can give me your opinion on how you receive value when a company pays you a dividend?  Lets say your stock is selling for $100 and you receive a $5 dividend.  The price is now around $95.  Where is the value to you derived?

Hey, Bill

Glad you picked SO.  I own a few shares.  It's a nice relatively low-yielding stock.  :)

Did you notice that on Aug 2, SO actually closed higher than it did on Aug 1?  Three cents higher with 40 cents per share owed to the owners.

It's noise and market forces at work in a circumstance where, on a given day, about 1% of the market price of a stock moves from cash on a corporate balance sheet to my account.

To your other questions, I guess I have more of an individual business perspective than I do a mutual fund/theoretical perspective.  I view a business as an engine, a potential creator of wealth.  A business utilizes a collection of assets - capital equipment, inventory, human, financial, etc. - to generate wealth.  Profits, if you will.  Many businesses generate profits well in excess of that which is required to invest in depreciated assets and new business opportunities.  When some portion of a successful business's profits are returned to the owners of the company, I do not consider that either (a) my capital is being returned to me or (b) the business has less value.

Although there are certainly many factors in the market's determination of value at any point in time, I daresay that many of us agree that earnings (and their growth) are a major determinant of value over time.  If a company distributes some cash to me out of its earnings in a manner that does not hurt its current or future earnings, I don't consider that the company is somehow worth less.

Again, the business is a creator of wealth.  As an owner, when I receive a dividend, I'm getting a piece of the wealth that has been created.  Yes, I know that, accounting-wise, the company's cash account has been credited and the equity account has been debited.  But that credit and debit transaction, by itself, doesn't come into play at all in any value analysis that I utilize.

I focus on the wealth-creation aspects of a business (the company return) and less so on the day-to-day or short-term gyrations of the market (the market return or lack thereof).  Although I do think of you on those days when one of my stocks goes ex-div and the stock closes up for the day.  :)

Regards

Cliff

Bill,

Fund NAV behavior is based on individual share price behavior, but is considerably more simplified.  That is, share prices vary during the day, while fund NAVs are based on market closing prices.

"And why does the price drop only for limit orders but not for everyone else?"

You can find this explanation on how the market (the NYSE) works in several places, but here is what happens:

First, pull this link up in another window.  This is the 5 day share price history for Frontline Tankers (FRO), a stock that I hold.  The five days are the day before Thanksgiving, the Friday after, then Monday, Tuesday, and Wednesday of this week.  FRO will pay a $1.50/share quarterly dividend, with an ex-div date of this past Monday.  So, those who owned shares on Friday, at the early closing of the market, will receive that dividend, which will be paid on or about December 12 to those 'on the books', as owners of the stock, as of November 28.  This dividend was announced on November 15.  Finally, for those interested, the total dividend for 2007 is $11, representing a yield of 23.55% at it's current share price of $46.70.

First some minutae.  Whenever you buy or sell individual stocks, you are given 3 business days to settle accounts.  So, if I buy shares, today, on the NYSE, this trade will 'settle' on Monday.  That is, the money for that purchase will be taken out of my Vanguard money market account on Monday and put into the money market account of the guy who sold those share to me, again on Monday.  That means that, on Monday, I am 'on the FRO books' as the owner of those shares, while the seller is then off the books as of Monday.  This is why dividends are always paid on a certain date to those of record on a previous date, and the ex-div date is always 3 days prior to the date of record.

Now, look at the minute to minute variation of the share price.  For example, on the day before Thanksgiving, the stock opened at $41.33. The chart tells you that, for the period of time between 9:30 and 9:35 that day, the high price was it's opening price, the low was a penny lower, and the price, at 9.35 AM was $41.32.  And you can see the variation of this share price over that 6.5 hours that the market was open.  Finally, the NYSE closed, and the closing price of FRO was $42.38, up $1.05 for the day.

My first question to you is what is the value of one share of FRO on that day?  Actually, it's value (share price) varied almost continuously over the day.  People typically value their holding at the closing price, since it holds this price from 4:00 PM ET one day to 9:30 AM the next.  Mutual funds look only at closing share prices to calculate their NAVs.  If you are interested in the variable (during the day) NAV, you are looking at an ETF.

Now on to how the NYSE operates.

Whenever anyone wants to buy, or sell, shares on an exchange, they send in an order (to buy or sell so many shares of such and such company).  They also say what price they are willing to sell, or buy, at.  The NYSE receives all of these orders, and maintains an order book.  That is a list of all buy orders and all sell orders, in order of the share price.

If any buy order matches a sell order, then the trade (buy and sell) is made.  If no matches exist, the order book still exists.  Usually, whenever you place a limit order, it will be good only for one day, or good till cancelled, again at your option.

However, you may want to either buy or sell 'at the market'.  That is, you are willing to buy at a share price that is the lowest sale price on the order book at the time your order is received.  Or you are willing to sell at the highest buy price on the order book at that time.

Anyhow, the instantaneous share price of an individual stock is the price at which the trade (transaction) occurred, on an exchange, between a willing seller of that stock and a willing buyer.  It's just as if you go into a house that's on the market.  It's listed at some price (the selling price), but you put in a bid at a lower price (the offer price).  Eventually your compromise, or you walk.  If you end up buying the house, you are a willing buyer, and the seller is also willing.

Now, what happens on the ex-div date is that, on the day previous, the closing share price is the price at which the last trade occurred, or the closing price.  Once the market closes, that order book above is adjusted.  That is, ALL limit buy and sell orders are adjusted downward, by the amount of the dividend.  In the case of FRO, that adjustment is $1.50.  If I was willing to buy 100 share, at $47, on the day before ex-div, I should be willing to buy 100 shares at $45.50 on or after the ex-div date.

Whenever the market opens on that ex-div date, a difference still exists between the highest buy limit order and the lowest sell limit order.  And nothing happens, until another order comes in.  If its a market buy order, it is executed at the lowest limit sell order on the books.  This will be a bit higher than the previous closing share price, minus the dividend, since it was 'on the books' at the previous closing.  Likewise, if the first ex-div market order is a market sell order, the execution price will be slightly lower than the previous closing.

The market then functions as it always does, remembering that the order book still exists, but the limit orders are adjusted downward by the dividend.  Whether share prices fall, or rise, during the day depend completely on the dynamic interaction between the market orders received during the day, and the limit orders on the books.

In fact, from any one trade to the next, you can tell (if you are really interested) whether the order being executed was a market buy, or sell, order.  Simply look at whether the preceeding trade price was higher, or lower, than the current one.

Now back to FRO.  On last Wednesday, the actual trade execution price is the price at different times during the day.  You can see that it opened at $41.33, fell momentarily to $41.15, rose to a high of $43.28. and closed at $42.38, for a maximum spread, during the day, of $2.13, and a spread, from open to close, of $1.05.

The next day, FRO opened at $46.09, fully $3.71 above it's closing the previous day.  It closed last Friday at $46, then went ex-div on Monday.  On Monday, it opened (the first trade of the day, matching a market BUY order to the lowered limit sell order of $45.22, which was only $0.78 cents lower than the previous close, not the $1.50 reduction due to the dividend.  During the day, the share price actually went above the previous closing price, at $46.23, at about 11:45 in the morning.  The stock closed at $45.00, which means the last sale of the day was down only a buck from the previous close, even though the stock was ex-div on that date.

Finally, if you go back to November 14 (the day before the dividend was announced), the share price was $38.92.  It closed $39.22 on the 15th.  So the stock rose $0.30 on the day the dividend was announced.  Finally, the stock rose $7.08 from the day the dividend was announced to the day before ex-div.

My point in all of this is that I am hard pressed to figure out how much of this behavior was due to announcing or receiving a $1.50 dividend and how much was due simply to normal market regurgitation of that dividend, earnings, and general financial health and profitability of Frontline.  For the most part, I don't believe those who purchased this stock this week gave a rat's beduzzy that it paid a $1.50 dividend!

Nor should you or I! 8-)

Bill,

"Maybe you can give me your opinion on how you receive value when a company pays you a dividend?"

The value of your portfolio rises, or falls, over time, as share prices and fund NAVs rise or fall.  On paper.  If it rises in value, you receive value.  If it falls in value, you loose it.  This happens regardless of whether or not you receive dividends.

If you DO receive dividends, that's value that you receive, but not on paper.  It's cold cash.  The value of your portfolio still rises, or falls, over time, due to share price changes.

In order to receive cold cash without receiving a dividend, you have to realize capital.  That is, you have to sell shares.  So, the value of your portfolio still rises, and falls, over time, due to share price and fund NAV changes,  But the value also falls a bit, at a given share price or fund NAV, whenever you sell shares.  The reason is that value depends on not only the share price or fund NAV changes but also on the number of shares that you own.

"All I have been saying is that unless the stock over some period of time rose $5 in anticipation of this future dividend, then how have you gained anything different then just selling $5 worth of shares?,"

Logically, then, how would you explain share prices that fall prior to the ex-div date?

All I have been saying is that changes in share prices appear to NOT depend on the amount of the dividend. 

"And why does the price drop only for limit orders but not for everyone else?"

The outstanding limit orders were placed with the expectation that they would receive the dividend. When the stock goes ex-dividend, these bids must be reduced to reflect the fact the dividend is no longer part of the future investment return.

Fundamentally, a stock's price is the last successful buyer's estimate of the present value of the stock's future investment returns. Different buyers have different estimates, so dividend amount often gets lost in the day's normal trading range. But you have to think that most buyers would include the knowledge of the lost dividend in the formulation of their bid.

"You are making a mistake failing to distinguish NAV growth due to speculation from NAV growth due to underlying earnings. Both are reflected in the share price, but one is temporary and the other is pseudo-permanent. I guess this is what drives you to the other extreme, ie high yield, which I view as risky because you're investing in companies with little growth potential for the sake of yield."

Here are the 79-year returns by dividend yield decile.

Stocks which have paid above average dividends have had higher total returns than other stocks. You often hear that people overpay for growth and avoid risky, or slower growing, value stocks. These returns are consistent with that thinking.

This data shows that as you get into the two highest yielding deciles, the price growth is lower and the dividend growth is lower, than the other above-average dividend payers. This makes sense because more earnings are being paid out as dividends, not retained for investment in future earnings growth.

The difference in growth rates is small enough where it might not be noticeable in the early years of retirement. But as time goes on the highest yielding stocks' dividends often fail to keep pace with inflation. In order to maintain your spending level, you are then forced to sell shares whose prices have appreciated at a slower rate.

"Logically, then, how would you explain share prices that fall prior to the ex-div date?"

Because share price changes are due to two different things in this case: 1. the normal influence of the market to all kinds of information, and 2. the influence of knowing that a the stock is worth more before the ex-dividend date than after.

The stock will normally rise approximately the amount of the dividend, which as you have pointed out is usually quit small in comparison to the price.  This rise may well occur in advance of the dividend announcement if an increase in dividend is anticipated because the buyer knows the stock will rise even more.

But it is easy for normal volatility to swamp these increases and a net decline can occur.  This is what I'm sure is happening with financial stocks that pay a nice dividend.

The point is, all things being equal, the share price for those financial stocks is higher than it would have been without a dividend being paid and higher by an amount that approximates the dividend.

Likewise, a day like today if it falls on the reinvestment day after a dividend may well show a large increase in price, but that increase is lower than it would have been without the dividend.

The math is inescapable to me.  Unless the share price rises before the dividend, since we know it falls after the dividend, you are not "getting" anything when you are paid a dividend except some of you own money back.

I started a new thread with two sources citing this concept.

best,

Bill

Bill (cont)

"except perhaps, I believe that principal is the amount you have at any given time in a portfolio."

Ok, I can live with that.  Then, whenever you receive a dividend from the company, a bit more principle is added to your portfolio.  If you withdraw a portion of that dividend, then you are spending principle.  The NET result of this series of actions (dividend receipt, principle increase, dividend withdrawn, principle decrease) is a net increase in principle (if you withdraw less than the dividend) or a net decrease (if you withdraw more than the dividend).

I believe 'principle' is the same as 'capital', and simply means the value of your portfolio at any point in time.  That is, it's the share price/fund NAV times the number of shares owned.  I believe 'yield' is the amount of stock dividends and bond interest generated by the portfolio.  I believe you withdraw and spend yield without realizing capital (touching principle), but realize capital (touch principle) whenever you sell shares and spend the proceeds.

"I DON'T BELIEVE THAT DIVIDENDS ARE RETURN OF PRINCIPAL.  I NEVER SAID THEY WERE (in general, with the exception of special dividends in some cases)"

STOP YELLING!  YOU AIN"T LALOBA. 8-)

Well, this is what I am hearing from you (that dividends are a return of principle.)  If principle is share price times the number of shares, and share prices drop by the amount of the dividend, then spending, rather than reinvesting, dividends equates to spending principle.

"Are you serious?  Of course it makes a difference."

I am saying that normal share price behavior (rising and falling share prices), such behavior being determined by market regurgitation of dividends, earnings, quality of management, and phases of the moon, is so much larger than the amount of the dividend that you can't really say whether that dividend is factored into the share price, or not.  I happen to think that it isn't, you think that it is.

My point is simply that if you structure your money management strategy (for example, as I have outlined in this thread) such that the primary goal of that strategy (funding retirement withdrawals) is FULLY satisfied by that yield, then you are isolated from the bad effects of falling share prices.

It seems obvious to me whenever discussing savings accounts, or money market accounts, or bond funds (think VWEHX).  It also seems obvious to me whenever you extend the concept to stocks.

FInally, these concepts apply whether you are talking about a portfolio that yields 1%, or 4%, or 7%, or 10%.  That is, there is nothing 'special' about a high yield portfolio, except that it supports either higher, or safer, rates of withdrawal then a low yield portfolio.

As I think about this, might it be that you are just used to thinking about stock fund dividend distributions, rather than bond fund interest distributions, or individual stock dividends?

Ok, i will try again.  I did try but a lot of this stuff is way over my head. I did sign up for the M* DividendInvestor newsletter of Josh Peters.  I'm slowly assimilating that.

"As I think about this, might it be that you are just used to thinking about stock fund dividend distributions, rather than bond fund interest distributions, or individual stock dividends?"

No.

This whole effort was about the concept that share prices have to rise (in general) in order for dividends that end up lowering the share price to actually be an increase in principal rather than a wash.  That's all.  Very simple.

I have yet to hear how giving me cash in one hand while taking cash away from the other (which is what occurs in the absence of price increase) adds to my portfolio value.

In essence, to use your analogy, you are going into the pizza shop and asking them to cut the pizza into 8 slices instead of 6.  You still have the same amount of pizza. 

But I do believe they rise, in general, and I do believe dividends add value so since you are not going to be persuaded by either my logic or my yelling:), I think this has run its course.

best,

Bill 

Bill,

Isn't it much easier to work with the $1.50/share dividend then to worry about what the market forces might do to share prices?

helmut,

"I just do not believe that higher yields are in and by themselves a barometer of a SWR."

The SWR depends on the amount withdrawn from a portfolio.  Specifically, a withdrawal rate is considered 'safe' if it lasts as long as you live, or as long as you need it to last.  Go back and read the discussion of Period Certain withdrawal strategies, as compared to Income Certain strategies.

All withdrawal strategies that withdraw LESS than the yield of the portfolio are non-trivial Period Certain strategies.  As your rate of withdrawal gets higher and higher above the yield of your portfolio, the strategy becomes more and more trivial.

By trivial I mean that the withdrawal, and portfolio, will last forever, but it's value approaches zero.  Think of a withdrawal strategy that spends 90% of the value of your portfolio each year.  It will last forever (you always have 10% of it's value remaining in the portfolio after the withdrawal), but that value goes down exponentially.  Think a portfolio value of $100,000 in year 1, $10,000 in year 2, $1,000 in year 3, $100 in year 4, and so forth.

Given the above, the criteria (withdraw less than the yield, reinvest the excess) works whether you are talking a portfolio with a yield of 2%, or one with a yield of 10%.  That is, the 100% SWR of a portfolio yielding 2% is 2%, while that of a portfolio yielding 10% is 10%.

Whenever you withdraw more than the yield of the portfolio, you 'touch principle', you 'spend capital', you gradually liquidate your portfolio.  You can do this safely only if you die before you liquidate.

So, to answer you question, I don't believe higher yields are a barometer of SWR.  The yield itself is that barometer.  That is, a 2% yield portfolio leads to an absolutely safe withdrawal rate of 2%, while a 10% yield portfolio leads to a 10% SWR, especially if you are prudent and withdraw less than the yield.

That is, higher yielding portfolios are a barometer of portfolios that support higher SWRs.

SWRs deal with money management during retirement.  The quality of the dividend reflects the ability of your portfolio to sustain a given yield.  Your 'quality', but low yield, companies support low absolutely safe rates of withdrawal.  Quality companies that pay a high dividend support higher rates of withdrawal.

"actual facts do not support your position."

I don't understand.  Are you saying that facts support your theory, specifically that the return you get from the market (share price appreciation) is more predictable, more certain, than the return you get from the company (it's dividend?)

Look, you get yield return and sometimes you get growth return.  I consider yield safer, more certain, than growth.  You obviously think the opposite.

"Is this what you call confirmatory evidence?"

No, I call it facts, not theory.  My savings account example is the 'withdraw less than the yield' concept applied to savings accounts.  Why do you consider this a 'theory'?

JWR1945a:

Your conformation bias tendency to give more attention and weight to data that support your beliefs than to contrary data is especially unreasonable when your beliefs are little more than prejudices....

If this were true, you would have a point.

Now move the double edged sword in the other direction. 

John Walter Russell 

John, you are the master of the non-sequitur and malapropism. The point made was regarding your conformation bias. An appropriate response might be to deny such bias exists, by pointing out with specifics how your own work accounted for a selection of examples that did NOT restrict the information space to only those tests that tended to reinforce your own initial hypothesis. Or, you might have responded that you accept the criticism as valid, OR you might have asked for some time to delve into whether there was any justification for the claim of such bias.

What would seem an utterly ridiculous response, though, would be one that mixes metaphors and is in essence equivalent to a finger-point with a sulky verbal "Oh, yeah? What about you?" added in for good measure.

Surely you can do better? Otherwise, one might begin to properly wonder about your logical reasoning skills.

Ken,

"I guess this sums up your rationale for investing such that you get as much of your Total Return from income as possible."

I get as much of my total return from income/yield as I need to fund my withdrawals.  Anything I don't need for that purpose stays in the portfolio, in the asset that generated the yield, or another.  Once that absolute need is met, then any return I receive (positive or negative) from share price changes is what it is.  I simply capitalize on the volatility, as I explained in the original posting of this thread.

That is, I don't RELY on realizing capital (selling shares) to meet those withdrawal needs.  If I did, the unrealized gains, each year, would have to be greater than the withdrawal in order to maintain portfolio value.  That implies share prices always increasing.  That's an assumption TR, or growth, focused investors have to make in order to have a safe withdrawal rate.

Go back to the simple equation I gave in this thread.

"There is no such thing as company generated return."

Yes there is.  I receive a check from the accounting department of each company I own, whenever they make a dividend payment.  They determine the size of the check.

The return I receive from the market, that is, realizing capital (the proceeds from the sale of shares) comes in the form of a check from a greater, or lesser, fool than I.

"You consistently imply that growth (NAV appreciation) is due to speculation."

No, I have always said that share prices don't always rise, which is growth.  Sometimes they decline, which is a loss.  The point is that share price behavior is volatile, implying that growth returns are volatile (actually, that's a definition, not an implication).  To me, that's risk, the uncertainty of share price related returns.  A risk you don't see in the volatility of the dollar amount of the yield.

What I have also always said is that there is NOT a direct, well defined, functional relationship between earnings and share prices.  That is, given earnings are such and such, share prices should be so and so.

As part of the 'Active Value Investing' thread a while back, I was very clear that people, such as Jack Bogle, define total return as having two components, what he calls the investment return and what he calls the speculative return.  The investment return is the yield, the speculative return is the share price behavior portion.

He, as well as I, as well as most everyone else understand that investment return is a function of earnings, that is, as long as you have earnings, then the company can pay a dividend.  But you need earnings GROWTH to get dividend growth, as well as share price growth.  Without earnings growth, any share price movement is speculative.

That is, in your vocabulary, an expansion or contraction of the P/E ratio is speculation.  And it's also clear that, if you focus on share price growth for the major part of the return you expect, earnings also have to grow!

"For us forum posters speculation does nothing for our portfolio value over the long term."

Well, do you think you are NOT speculating if you invest in a company primarily for the growth component of total return?  You expect EPS to continue to grow, year after year, otherwise share prices won't grow!  You also expect the market, efficient or otherwise, to corectly price the shares with regard to that EPS growth.  In fact, you are speculating on a whole bunch of things to occur, all favorably, the bottom line being share prices rise.  Then the unexpected happens, and share prices tank.

Given all of the above speculation, you then estimate, or expect, a certain growth return.  That, typically, will be somewhere in the neighborhood of 6-10%/year.

For a yield focused investor, we speculate that the company will pay it's regular dividend quarter after quarter, year after year.  Our greatest risk is that it cuts, or eliminates, its dividend.  Given this speculation, we expect the yield return to be the yield paid by the company last year!  That, typically, will be the percentage yield of the company, fund, or whatever asset that we happen to choose, whether it be 6%, 10%, 1.75%, or zero %.

"Reinvestment is required to keep pace with inflation, build new facilities, purchase the latest widgets that improve efficiency, conduct R&D, etc. Do you really believe a company that is not doing these things with E/FCF is less risky because it's paying out everything to shareholders? It's a dead-end investment, in fact it's really short term speculation in the sense that you're gambling to get back more in dividends than what you invested...knowing full well there's no future."

Now your reaching, and getting into 'quality of dividend' issues.  Specifically, you're talking about the dividend payout ratio, that is, the fraction of earnings paid out as dividends.  Retained earnings ratio is 1 minus the payout ratio.  That is, if a company earns $3/share/year, and pays a $1.50 dividend per year, it retains $1.50, for all of the reasons you listed, even those already subtracted from profits to calculate earnings.  Both the dividend payout ratio and the retained earnings ratios are 0.5.

Now, tell me why it's better for a company to retain the whole $3, rather than just $1.50?  Do they need the extra buck and a half for overpriced acquisitions, or to pay for improperly priced stock options given in lieu of salaries?  'Howzabout a buck or so, per share, for super-widget, that never makes it past the first line manager of the R&D department?  'Maybehaps a few billion to cover subprime loan losses!

Then, given that the company DOES pay the $1.50, does it make any sense that this stock is more risky, at $15/share (a 10% yield) than at $75/share (a 2% yield?)  It's the same $1.50 being paid, by the same company with the same fundamentals, management, same everything!

"You are making a mistake failing to distinguish NAV growth due to speculation from NAV growth due to underlying earnings."

You are making the mistake in thinking that share price growth depends upon earnings, not earnings growth.  That is, the mistake is thinking that share price growth without earnings growth is NOT speculation.  All growth focused investors make this mistake.

"drives you to the other extreme, ie high yield, which I view as risky because you're investing in companies with little growth potential for the sake of yield."

So, you view high yield (say, 10%) as risky, but not 2% (in my above example), even though the ONLY difference between the two was share price?

Think about it.

Mathguy2,

Although I understand the Dividend Discount Model, and have played with it quite a bit, do you really think anyone would use it to place buy or sell orders for stocks?

"But you have to think that most buyers would include the knowledge of the lost dividend in the formulation of their bid."

Whenever I buy or sell, I rarely use limit orders.  I buy or sell at market.  The few extra dollars I might receive by using limit orders are well spent in knowing that I'm buying, or selling, close to my target prices, as explained in this thread.

Mathguy2,

"This data shows that as you get into the two highest yielding deciles, the price growth is lower and the dividend growth is lower, than the other above-average dividend payers. This makes sense because more earnings are being paid out as dividends, not retained for investment in future earnings growth."

Total returns, including dividends, were also lower.  Rather than making sense, this can't be the reason, unless you also looked at the dividend payout ratios.  That is the measure of paid, versus retained, earnings.

A more plausible and logically consistent explanation is that these high dividend payers over the years are the ones in the final death throws of their existance, thowing dividend money out to attract investors.  The buggy whip boys, as it were.  It's impossible for all companies to continue to grow, indefinately.  Bernstein even had a paper on this subject.

Regardless, the data is what it is.  What would be interesting is to see if statistical analysis of this data shows any causal relationship between the growth portion of TR and the yield portion.  That is, is the amount of growth return you receive expected to be about the same, regardless of the yield portion you expect?  Or do you give up growth return if you focus on yield return.  A quick examination of the data does't seem to show any trend.

There is an unbelievable amount of garbage in this thread and on this forum in general.  Anyone treads into this cesspool needs to do their due diligence - PLEASE.


The fact that stock price should fall given a dividend, all other things being equal, is because retained earnings are reduced.  Current assets fall (cash), working capital suffers, various debt/equity metrics (which determine cost of capital) are worsened, and growth potential is stunted.

This is not to say that dividends are bad - they are a useful, but somewhat tax inefficient, way to distribute earnings to shareholders.  For a mature and profitable firm dividends should be encouraged.



 

mathguy2:

"You are making a mistake failing to distinguish NAV growth due to speculation from NAV growth due to underlying earnings. Both are reflected in the share price, but one is temporary and the other is pseudo-permanent. I guess this is what drives you to the other extreme, ie high yield, which I view as risky because you're investing in companies with little growth potential for the sake of yield."

Here are the 79-year returns by dividend yield decile.

 

Div Yield	Total Ret	Total Ret	Dividend	Div Growth
Decile	Incl Divs	Excl Divs	Return	1928-2006
No Divs	8.24%	7.65%	0.61%
Low 10	8.68%	6.72%	1.94%
Dec 2	10.11%	7.13%	2.97%
Dec 3	9.63%	6.14%	3.45%
Dec 4	10.83%	6.79%	4.02%
Dec 5	9.23%	4.81%	4.41%
Dec 6	10.33%	5.40%	4.96%
Dec 7	11.49%	5.98%	5.54%
Dec 8	12.19%	6.12%	6.11%
Dec 9	11.36%	4.52%	6.93%
High 10	11.20%	3.28%	8.03%	3.69%
Total Market	10.03%	5.86%	4.19%	5.39%
High 30	11.75%	4.95%	6.87%	5.46%

Stocks which have paid above average dividends have had higher total returns than other stocks. You often hear that people overpay for growth and avoid risky, or slower growing, value stocks. These returns are consistent with that thinking.

This data shows that as you get into the two highest yielding deciles, the price growth is lower and the dividend growth is lower, than the other above-average dividend payers. This makes sense because more earnings are being paid out as dividends, not retained for investment in future earnings growth.

The difference in growth rates is small enough where it might not be noticeable in the early years of retirement. But as time goes on the highest yielding stocks' dividends often fail to keep pace with inflation. In order to maintain your spending level, you are then forced to sell shares whose prices have appreciated at a slower rate.

It looks like the numbers confirm a dividend based strategy.  El Lobo has already talked about what might impact the data in the highest deciles and I'm discriminating based  on just dividend based investing rather than high yield investing.  When you start looking at the middle to third deciles both the total return and dividends are higher than a market portfolio.  But what really intrigues me and I don't know if the data is available would be the difference between the U.S. market data and some of the European markets where dividend investing is much more the norm and has received more favorable tax treatment.  In this country, dividends go in and out of fashion, and again, I don't know if the data is available, but wonder if the data were correlated with when dividends were in vogue or had a more tax tax treatment if the results would be different.  Are some important aspects of all of this lost in the aggregation of data?  Does the time period selected impact the results?

Roberta 

I'm glad you were able to decipher what I was trying to get across to EL.

I notice the tendency in the data for higher yield to have higher TR.

O'Shaughnessey and Damodoran showed that high yield alone doesn't beat the market.

Also, O'Shaughnessey looked at this on a capitalization and risk-adjusted basis and found the only "HY premium" is for HY US megacaps.

I'd be interested in your comments re cap and risk.

Good Luck, Ken.
 

Bogle didn't say there are 2 components to TR, he has always said there are 3:

1) Growth

2) Dividends

3) Speculation.

In his recent book he has warned investors not to expect speculation to bolster returns, the speculation excesses of the last bull need to be undone.

Don't be getting cute....

Bogle defines the investment return as the initial dividend yield plus the earnings growth rate.

Total return = investment return + speculative return

Have fun.

John Walter Russell 

El Lobo

No, I call it facts, not theory.  My savings account example is the 'withdraw less than the yield' concept applied to savings accounts.  Why do you consider this a 'theory'?

Your theory lies within your implication was that the risk on the interest and principal of a federally insured bank savings account is the same as a stock such as NAT or RAS as long as you take a distribution that is less than the yield. That type of assertion is frivolous to me. 

The SWR depends on the amount withdrawn from a portfolio.  Specifically, a withdrawal rate is considered 'safe' if it lasts as long as you live, or as long as you need it to last.

Yields do not guarantee SWR as you define them, earnings (profit) do. Without earnings you have nothing. The ability to earn profit along with the intrinsic value of a company determines the true value of a company. If you have a major long term drop in share value (reversion to the means) it means you paid too much for speculation.

The Russell 3000 only has 52 stocks that have a yield of 1% or more with a consecutive 20 year dividend growth record. Of those 52 stocks only two have a current yield of 6% or more. Dividend growth rates are even bleaker when the yield goes over 7%. Of all the Russell 3000 stocks yielding 6% or more only 14 have consecutive dividend growth for 10 years. Six have consecutive dividend growth for 14 years. Of all the stocks yielding 6% or more only five had consecutive earnings growth of 1% or more for as long as four years.

Bottom line earnings growth leads to dividend growth. Without dividend growth higher yielding stocks are more likely to encounter not only share value volatility, but dividend volatility as well. Now if you want to say you don't need dividend growth if you re-invest part of the dividend to grow your dividend, you still will have dividend volatility which will create the risk and uncertainty that you are trying to avoid in the first place.

This debate has not touched on the risk of bankruptcy. If you want to argue that NAT is a safer stock than XOM solely because it has a higher yield, you will have to take the risk of that being called a frivolous statement by me as well.

Whenever you withdraw more than the yield of the portfolio, you 'touch principle', you 'spend capital', you gradually liquidate your portfolio.  You can do this safely only if you die before you liquidate.

If you want to parse words to win the debate so be it, but as long as your portfolio increases in the long term and you take less in the form of a distribution than the increase you will not liquidate your portfolio. If your distribution is more than the increase you will liquidate your portfolio. The size of the yield will not prevent that.

As far as separating theory from fact, just about every one of your post regarding SWR is theory with very little in the way of facts to support them. Even the Bernstein study that you quote so often to discredit income certain withdrawal strategies does nothing to support any of your high yield SWR theories.

As far as the investment strategy outlined in the beginning of this thread, I see no substance to back it up. That does not mean it will not work, but it has much less creditability than even the simple Dogs of the Dow dividend strategy which has averaged an annual total return of 17.7% since 1973.

I don't understand.  Are you saying that facts support your theory, specifically that the return you get from the market (share price appreciation) is more predictable, more certain, than the return you get from the company (it's dividend?)

If you don't understand, then it is your conformation bias that does not allow you to even acknowledge, much less dispute any of the facts I have presented over the course of our debates showing that a total return strategy can be just as successful as any of the high yield SWR theories you have present thus far.

helmut 

Latest buzzword:

If you don't understand, then it is your confirmation bias that does not allow you to even acknowledge, much less dispute any of the facts I have presented over the course of our debates showing that a total return strategy can be just as successful as any of the high yield SWR theories you have present thus far.

Any truth supported by mathematics and history is called "confirmation bias."

Have fun.

John Walter Russell 

A total return strategy can work well when valuations are low at the beginning of a bull market.

A total return strategy worked great during the 1950s. It was lousy during the 1960s.

Have fun.

John Walter Russell 

JWR,

"A total return strategy worked great during the 1950s. It was lousy during the 1960s"

Will the 2010's be like the 1950s, or the 1960s?

(My guess is more like the 60s, because of valuations).

A yield based strategy works well in any market.

Helmut,

Good luck in your upcoming retirement.  Yield focused investing isn't for you.

Warmest regards,

Chuck

"I'd be interested in your comments re cap and risk."

Ken,

I don't pretend to have any special insights into this, but here is the data I previously posted along with the Dec 2006 average market cap (in millions):

As you would expect, the no dividend group is predominantly small cap. Decile 9 is significantly larger than the other dividend payers and Decile 10 is significantly smaller. The other above-average dividend payers (Deciles 5-8) are somewhat larger than the lower yielding dividend payers.