Some of you might have noticed in the most recent updates of the USDP (Ultimate Sustainable Dividend Portfolio) that while its performance has been incredibly solid, it does lag the total return of a broad market index such as the S&P500. I do compare the two every month because it does help me in evaluating the returns of the USDP. That being said, there seems to be a big debate about the over or underperformance of dividend portfolios when compared with traditional long market portfolios, which are now easy to replicate thanks to ETF’s (more on that later). That is nonsense. I’ve been testing my theory with a few hundred members from our dividend focused newsletter. Today, I wanted to explain why I don’t think it makes sense to compare for most dividend investors.
I would love to get feedback from both dividend investors and critics. Here are the reasons why I think your focus should be on cash flows rather than beating the market.
Different Mindset and Objectives
Hedge funds, private equity, insurance companies, retail client and sovereign wealth funds… There are so many different types of investors and they each have their own objectives. I think it’s fair to say that asset allocation and other investment decisions should always be made in regards to one’s investment objectives. There are many different possibilities but in the end, as investors, we must all find our own. As you know, I’m a believer in many different types of such strategies. I’ve been very vocal about my dividend portfolio, long and short tech stock picks, my ETF portfolios but also longer term speculative picks such as my purchase of Facebook ($FB) last week. All of those are not mutually exclusive. I could easily move to more or less strategies over time (day trading, momentum, etc). For now, those are the 4 that I use for my own portfolio.
It’s easy to knock down any one of those strategies but the recent surge in popularity of dividend investing has made it a popular target. Dear critics, who are you to knock down dividend investing? I would venture that in general dividend investors are looking to create a stable, growing passive income stream that can either supplement or fund their lifestyle at some point. Dividend investors generally have very clearly defined objectives which are not calculated in terms of portfolio value but rather the amount of money they can expect to receive every year. There is tremendous value in having clear investment objectives as I will discuss later on in this post.
I will start by stating the obvious. Dividend stocks should and do react in different ways compared with other assets. You could always find exceptions but it’s safe to say that as a general rule, dividend stocks are more stable, less volatile than broad market indexes such as the S&P500. Why? There are many reasons but generally, companies that pay dividends are more mature and reliable.
Since there is no such thing as a free lunch, it means that in some periods, dividend stocks as a whole would tend to outperform the broad market while in others they would not. In this case, dividend stocks will tend to outperform in declining/flat markets but would underperform in rising markets. This would not always be the case and depends on the type of dividend stock that you take (higher yield, focused on growth, etc).
Total Return Still Matters
One argument that I often hear regarding dividend investing is that only the dividend matters. That is silly of course and I don’t think many dividend investors focus only on that aspect. If so, buying high risk stocks such as FTR in the US would be their main strategy. My main strategy is to look for long term sustainable dividend stocks that will not only pay high and fast growing dividends but also have a strong underlying business which will ensure that the stock price also follows. I think this is a critical aspect that is often not explained enough by dividend investors giving some the impression that we only care about dividend yield. That isn’t the case of course.
That being said, when I looked at the differences between buying an annuity or a dividend portfolio, one important point that I stressed was the fact that dividend investors should have a different mentality. If your investment objectives are expressed in terms of cash flow that you are and will receive in the future, then you should not be looking at the daily fluctuations of your portfolio’s value on a daily basis. It’s not that I don’t care about total return but simply that since my objective is not measured in those terms, there’s no point in being too focused on it either. My portfolio’s main goal is to provide income that I can live off of. I don’t care if it performs better or worse than my neighbour’s. Obviously, depending on market conditions, many types of portfolios would outperform mine. But trying to time your portfolio strategy depending on the market will very rarely be a winning strategy.
I would compare it to my house which I intend to live in for a very long time. I do stay updated on its value but its not a huge focus because the main objective of my house at this point is simply to live a comfortable life.
As a reminder, one of the main reasons why I’m a believer in dividend stocks is the fact that it provides a clear investing methodology. As an investor, I can simply look at the following:
-How much is this company paying?
-What can I reasonably expect payments to be given its history, its underlying business?
This becomes a much easier decision to make than buying or not Facebook ($FB) or Apple ($AAPL) at its current valuation.
While I don’t care about beating the overall market, I do still want to optimize my returns for a given level of risk. In most cases, that means holding a diversified portfolio that holds small and large stocks from different sectors of the economy and that operate in different locations around the world.
Alternatives To Dividend Investing
While it’s true that dividend investing is a great fit for many investors, it’s very possible that you will prefer investing some or all of your resources in other strategies. In terms of long term/retirement investments, I personally consider building an ETF portfolio as the main alternative, that can also work out very well.
What Are Your Thoughts? Are You A Dividend Investor?
If so, do you care about being indexes?