Income Investing

[hendi_alex]

I ran this comparison because of comments made on my Income Investing board at I.V. Would be interesting to compare the roughly ten year performance versus a typical DG type of stock or versus a DG ETF. My main point is that a steady stream of income can be squeezed from any type of stock as long as the underlying company is executing well. To me total return is the trump card. The higher total return stockover a period of years will provide greater potential harvests than any dividend stock, regardless of the yield and regardless of the rate of dividend growth.

Here is my comparative analysis, cut and paste from my IV post.

"Yes Facebook, google, twitter, they are not going to be paying out divs any time soon so a need for income won't be met through that venue, although maybe Apple might help out. "

I've never understood this attitude about income versus growth. To me there would seem to be no real difference between dividends declared versus selling a few shares to capture corporate retained earnings. One decreases the value of the position no more than the other. Income can be harvested anywhere that an investment is generating earnings or free cash flow.

Just for example Two ETFs were chosen: VNQ and IWF. VNQ is a REIT fund and IWF is a fairly balanced growth fund. An approximate 10 Year span was reviewed.

$10k was used to buy 189 shares of VNQ at the, beginning of 2005 for $53, the mid range price. Dividends in 2005 totaled $3.56 per share or $673. At the end of 2014 the dividend was $2.92 ($552 per year) and the share price was $81 (NAV = $15309). The most recent close is $72 (NAV =$13608).

To keep it simple for IWF, 4% of shares were sold each open in January. The position started with 208 shares and ended with 144 shares. ETF distribution gradually increased from $0.32 to $1.27. The first year's dist + div gave $475. The 2015 dist + div gave $742. NAV after the distribution sat at $13,968. At $94 per share, the current NAV of remaining shares is $13,536.

If calculations are correct, IWF appears to have been the superior choice with its increasing stream of cash flow coming from share price appreciation combined with significantly increasing dividend steam. Both positions have retained comparable value through 2014, but while the annual distribution of VNQ had dropped to 3.6%, the harvest for IWF had increased to 5.3% or as noted above $552 versus $742.

My point is not that one approach or the other is superior, but rather that the terms growth or income are very misleading. Any investment class in the market can be systematically milked for income, and can be done in such a way as to not burn through principal. All stocks are 'income' if that is how the investor wants to use them. Most of my ETFs yield less than my eventual target withdrawal rate of 4%-5%. Not to worry! Shares will be liquidated to make up the differce and IMO there is little danger of dipping into principal over the longer term.

[hendi_alex]

Just ran 'total return' comparison chart to see how 'dividend appreciation' type of ETF (VIG) compared to REIT (VNQ) and to the more growth oriented fund (IWF). Had to trim the date range as VIG was only issued in 2006. At least for this span, DG wasn't all it was cracked up to be as opposed to IWF which is sold as growth, but also include a lot of dividend growth in its results. My guess is that the out performance comes because smaller cap growth are going to be able to grow earning better than the big cap DG stocks and they will be able to growth dividends at a healthy clip as well. They probably represent better opportunity than the large cap DG stocks yet are only modest more volatile. It appears to me, that relying too much on a single theme can seriously affect overall performance. For me, big cap DG types of stocks will never represent more than about 20%-30% of the portfolio value. It would make sense that potential for all aspects of growth, including dividend growth, lies in the smaller, less mature companies, and that is where I want the lion's share of my investment dollars.

[Caversham]

I'm not sure why anyone would invest in VNQ if it has cut its "dividend" from $3.56 to $2.92. A monkey throwing darts could have done better than this. My guess is that VNQ does not focus on stable, reliable income which means it is not a very good comparison against DGI.

The comparison between VIG and IWF seems better. However, I'm not sure your calculations include dividend reinvestment. If they don't, then you're ignoring one of the biggest benefits of DGI, compounding dividends.

Finally, VIG's current yield is only 2.3. I think most DIY DGI investors have an average yield that is higher than this, and would therefore benefit more from compounding.

[hendi_alex]

Dividends represent new cash. They can be invested anywhere. One would think that the smartest course is to deploy dividends in buying the best current value that is available, not simply buying shares of a stock because it provided the dividend. For the period of the chart above, DG investors would have been better served by investing all of their dividends into shares of IWF which in hind sight was clearly the best value over the duration.

VNQ is a REIT ETF, holding a wide range of blue chip REITs. I don't know why the distribution has decreased. My guess is that the higher payout year there were some capital gains distributed. The dividend stream itself has almost certainly increased. I am sure that many on this board hold tickers that are included in VNQ. Most pay good dividends but are not generally great total return candidates.

The more I dig, the less it appears that the big cap DG stocks are particularly great total return candidates. The best opportunities seem to lie in small cap and mid cap growth stocks. I'm focusing more on those areas, but am emphasizing growth stocks that also pay dividends. Am not interested in finding single issues from the maze of tickers in this large subsector, so will mostly limit investments to a diversified basket of ETFs. The portfolio will also include big cap DG stocks, but those mostly won't be purchased until valuations are much more favorable than they are currently. I'll be looking for P/E's between 12-14, companies with low debt, low pay out ratios, and lots of cash on the books.

[Dividendsrule]

For me the problem is always the lost decade of 2000-2010. If I relied on capital appreciation strategies and needed to retire around that time, I'd be in a tough spot. I did some hunting around to try to replicate your 3 funds above.

From 1/2000-1/2010, IWF returned -4.6% annually, dividend reinvestment included.
FRESX, a Fidelity REIT fund, did better, returning 9.6% per annually.
Finally, VDIGX, a Vanguard dividend growth mutual fund, returned 2.1% annually in that time frame (see low-risk-investing.com).
That is an average portfolio appreciation of 2.36% per year.

Also, VNQ cut their dividend 5 times in the past decade. I will list their distributions according to dividend-stocks.com from 2005 and onward: 3.56, 3.25, 3.11, 3, 1.96, 1.89, 2.05, 2.34., 2.79, to 2.92 in 2014.
8% of VNQ is Simon Property Group, which cut their dividend by 51% in 2009. 3.89% of VNQ is EQR, which cut their distribution in 2009, and again in 2010. VNO, 2.36% of VNQ, is littered with dividend cuts in the past decade.

So if we have some years of flat equity growth ahead of us, I would question the viability of "systematically milking for income" any equity class. It is precisely then that i would treasure my individual Coca Cola, Procter and Gamble, WPC, O and the like, because they have proven to me through thick and thin, recession and depression, that they can keep paying me rising dividends without cutting my income, typically regardless of how the stock price performs.

Some companies' dividends have been historically quite predictable. Asset values are not predictable year to year.

[hendi_alex]

I agree with all of your points. My counter point is that we don't have a clue what the next ten years will hold. Because of that ignorance, I prefer to rely on a mixed approach, rather than choosing a single approach and declaring it to be the holy grail of investing. As posted before, probably 20%-30% will be invested in big dividend growth stocks picked by individual ticker. Perhaps another 10%-20% would also fit the DG growth model, but will come from overlap in variously themed funds. 10%-20% will consist of REIT exposure. 10%-20% MLP exposure. 20%-30% energy exposure. 10% other than energy commodities. Funds will be further diversified by US/ex. US and developed vs emerging. At some point, a significant allocation may be given to fixed income, but that is likely pretty far into the future.

For sure there is no correct answer to this investing riddle. It seems to me that the best one can do is educate, find a comfort zone that appears to meet needs, develop a plan, and then stick to it making any changes based upon reflection rather than emotion.

My main purpose posting on this themed site is to suggest that a diversified approach which includes several strategies may at least be worth a look.

You bring up anther great point about which much has been written. It is probably worthy of its own thread. The topic: the affect that the timing of retirement has on the probability of outliving one's portfolio. This factor is huge for most investors who are only marginally funded for retirement. Another related topic that might be worth revisiting is the 4% rule.

[Dividendsrule]

Your portfolio allocations seem sounds to me, the way you described them above. Furthermore, I am happy for you that you have found a comfortable investment strategy that works well for you.

However, I take issue with some of the uncertainties you describe. You say "we don't have a clue what the next ten years will hold." You also describe "choosing a single approach and declaring it to be the holy grail of investing".

Owning a business or cash producing entity and being entitled to profits or cash flow is basically what investing is all about, and has been for thousands of years. So I don't know many other ways of investing. I guess certain funds and indexes pool many different companies together for the benefit of making sector investing easier for those inclined to invest that way. But investing is putting money aside with the desire to have it produce more for you in the future.

By attempting to cherry pick the highest quality companies and those which succeed to maintain or raise their dividend through economic recession, I hope to mitigate risk of capital loss, dividend cuts, and too much portfolio drawdown.

By simply buying a sector fund as you describe, I am also including businesses that I know very little about and have performed poorly in the past.

Like I mentioned, 8% of VNQ is Simon Property Group. Simon deals primarily with malls. I personally would not feel comfortable having 8% of my REITs as a pure play mall. I am 34 years old. Millenials growing up may not be as involved with malls as the prior generation. Furthermore, malls may not do as well as triple net leases in coming recessions. So I have a lot of runway ahead (as do you, if you live 30 more years and I hope you do) to be concerned about.

If you already have your needs met via social security, pensions, and other cash flows coming in, indexing and sector allocation might be good for you, and I hope you succeed with your portfolio in the future. For me, cherry picking and being picky about my investments are an excellent use of my time, I feel. It is a similar way of investing but with more care about the companies (I have around 80 companies in my portfolio and I look at around 130).

As far as not having a clue about what the next ten years will hold, I have plenty of clues. People will keep consuming Coca Cola products, Pepsi, my NNN leases are on average around 10 years long, people will still consume energy, population will grow, inflation will grow, minimum wage will grow, I will still keep getting paid. I keep it simple.
Pepsi is like a food and beverage mutual fund in and of itself! Tropicana, Quaker Oats, Rice Pilaf, Frito Lay, Naked juice...Coca Cola has Zico coconut water, Honestea, Minute Maid, over 500 brands worldwide. Etc.

As you mentioned, this is a themed website (dividend growth forum) so I don't think I'm out of line in defending dividend growth strategies here.

[cannew]

There was a similar post where an individual, close to retirement, changed his approach to investments. Part of his statement was:
"I’ve owned lots of good dividend stocks and dividend oriented ETFs like XDV and CDZ in the past but I’ve ditched them all. It took me a couple of decades to arrive here but I’m happy with mostly broader-market ETFs now.
Some of the ETFs we own are: VTI, VEA, VWO, VCE, ZRE and we give the equity side a tilt to lower volatility with ZLB and USMV. My overall ETF cost is around 0.17% on equity assets. On the fixed income side there simply aren’t good options out there currently, due to the interest rate environment."

I'd stick to DG stocks, but looked into etf's and responded:
"Looked at ETF’s which would include the stocks I own and calculated the annual Mer (which averaged 0.32%). The three funds were ZDV, ZRE & ZDY and it would cost me $5,292.19 per year, approximately 6% of my current dividend income. Seems like a lot of money just to spread my money over 172 stocks than the 20 which I researched and feel good about."

It's not that one choice is better or worse, it's what one expects & how one feels about the choices they make.