Investing for Total Returns
I came across an interesting forum post on bogleheads.org. (For those of you unfamiliar with the name, John Bogle is the founder of The Vanguard Group. He advocates investing in cheap index funds.) I was trying to get to Dividend Mantra’s site to see if any changes have been made there. The only thing I could see is that the controversial last post was removed.
In the post above people commented that he was not beating the S&P 500 and should have just put his money into a dividend paying Vanguard ETF and call it a day. A few people brought up the concept of investing for total returns versus investing for dividends and dividend growth. Some people seemed to think that one is better than the other.
In reality, the goals of generating a larger total portfolio value are the same; the methods of getting there and the needs of each investor are different.
Which of these is better? The portfolio that either doesn’t pay a dividend (or pays very little) but grows faster. Or the portfolio that may not grow as fast but is generating income along the way? The answer is, it depends. Everyone is at a different stage in life. Some need that dividend income to pay for bills, others could let the stock grow without collecting the dividend.
Commenter ‘ogd’ on the Boglehead’s forum says it best:
Total return deserves a privileged place for a reason: if I have higher total return than you, I can buy your portfolio, but more of it, and beat you on any measure you care to put on the table. Dividends, growth, capital gains, you name it. That’s why it’s the ultimate measure. That’s why “total return investing” is simply “investing”.
People that are relying on dividend income to live, will obviously want to own stocks that pay dividends or else they’d be forced to sell portions of their portfolio in order to generate income.
Although I generally consider myself a dividend investor and describe that strategy to others, I do so not because I only invest in dividend paying stocks out of principal, but because I think that over time, dividend paying stocks will tend to out-perform stocks that do not pay dividends. My thinking is completely on total returns, which encompasses growth of the stock plus dividends plus dividend growth plus buybacks.
Whatever it takes to get the portfolio value the highest is the key. As ogd said, if I have a higher value portfolio than you but you’re making 4% a year in dividends, I can swoop in and buy a larger amount of that stock and instantly be making more per year in dividends than you are.
If you’ll take a look at my portfolio, you’ll notice that while most of my stocks do pay a dividend, some do not. The hope is that the overall growth of those non-dividend payers over a 20+ year period of time will more than make up for the lack of dividends by giving higher overall capital gain when all is said and done.
Tax consequences of dividends are also an issue. Tax rates on qualified dividends are very favorable. However, you’d not owe any taxes on a growth stock until you decided to sell, and then the same favorable tax rates apply. Also, since corporations pay dividends with post-tax money and the shareholders that receive those dividends have to pay taxes again, dividends are effectively taxed twice.
Another reason I like investing in individual stocks, be they dividend paying or not, is that it is fun. Others may dislike the time required to research them, but I enjoy it.
Another consideration is that I feel I can get a higher dividend growth rate by investing in a few select individual stocks rather than lumping all my money into a single dividend paying ETF.
Although investing for total returns is the key, perhaps some of the benefits of dividend investing is actually seeing that cash entering your account. It sure is fun to keep track of the yearly increases in dividends that we are all seeing through combinations of dividend increases and injection of more capital.