ABCs of Behavioral Biases (A to F)
Four self-inflicted biases that knock a number of investors off-course are anchoring, blind spot, confirmation and familiarity bias.
In Part 1 of What’s Wrong With Depending on Dividend Stocks?, we described why dividend investing, or stocking up on stocks with a reputation for consistently paying out attractive dividends, may not be an ideal strategy for generating a dependable income stream out of your investment portfolio.
Today, we will look at why we prefer a total return investment strategy instead of seeking more concentrated dividend stock positions, even for retirees who are drawing income out of their portfolios.
Admittedly, there are more dubious ventures than concentrating on dividend stocks. Take, for example, piling your life’s savings into speculative investments such as cryptocurrency, SPACs or Jim Cramer’s latest “Mad Money” picks.
But rather than settling on dividend investing, here are two questions for homing in on a better way to build and spend your lifetime wealth:
1. Investing: As you invest and accumulate wealth over time, how can you pursue the highest total return over time, given the level of market risk you can tolerate?
2. Divesting: As you take income out of your portfolio, how can you best maintain its risk-managed structure, while generating the most tax-efficient withdrawals over time?
Where dividend investing falls short on these pivotal counts, total return investing is better structured for directly addressing them, head on.
Bottom line, there are essentially three ways any given investment can reward investors:
1. Interest/Dividends: A security can pay out more or less interest or dividends.
2. Capital Appreciation: A security can offer higher or lower capital gains or losses (based on how much you pay per share versus how much your shares are worth when you sell them).
3. Cost Control: As you buy and sell your holdings, you can incur more or fewer taxes and other costs that eat into your returns.
Instead of seeking to isolate and maximize dividends as a single solution, total-return investing seeks to make best use of all three of these potential money-making tools as they apply to you, your investment opportunities and your personal financial goals.
Total return investing offers more flexibility for pursuing overall expected returns within your risk parameters, regardless of where those expected returns come from.
Also, dividend investing limits you to investing in no more than about 40% of all publicly traded stocks. With total return investing, we can consider the entire universe of available stocks.
As we will see next, evidence suggests this is an important differentiator.
Total return investing is grounded in decades of academic evidence identifying the stock market’s true sources of expected returns. These include investing in stocks versus bonds to begin with, as well as incorporating return factors such as company size, book value and profitability.
The research is clear. Whether or not a company pays out dividends is NOT among these identified return factors. We have known this since at least the 1960s, when Nobel laureates Merton Miller and Franco Modigliani published their landmark study, “Dividend Policy, Growth, and the Valuation of Shares.” They found, if you omit external factors such as trading costs and taxes, investors should be indifferent to whether companies distribute shareholders’ profits as capital gains or dividends.
In a recent VettaFi Advisor Perspectives piece, Larry Swedroe of Buckingham Wealth Partners revisited this conclusion with his own analysis of four popular dividend-appreciation ETFs. He looked at whether they outperformed their counterparts after accounting for the types of investment factors that drive expected returns.
Swedroe concludes: “Be skeptical of strategies that conflict with economic theory. Even without considering the negative tax implications of a dividend-paying stock … investors are better served by directly targeting factor exposures in their portfolio rather than using a dividend screen, which reduces the investable universe significantly.”
As total return investors, we can still draw from and make best use of available dividends and interest. Because, on a purely rational level, a dollar is a dollar and a return is a return, no matter how it is paid out.
But whenever it may make more sense to do so, we can also sell positions to generate income. We can also prioritize managing an investment portfolio and income withdrawals as cost and tax-efficiently as possible, without having to maintain a dividend-stock exposure.
By building from this position of strength, you can pursue the outcomes that make the most sense for you. Would you like to have more income to spend in the end? Experience less market volatility along the way? Create a balance between growth and stability? Total return investing gives you far more ways to mix and match the pieces of your portfolio accordingly. In fact, most total return portfolios still include dividend stocks; they’re just no longer a central pursuit.
Portfolio Management
Concentration Risk
Tax Management
By concentrating on dividend stocks, investors are inadvertently investing in a byproduct of the market’s actual sources for expected returns. Why not invest directly in these sources themselves? By focusing on your portfolio’s total return as the horse that drives your proverbial cart, we believe we can best manage expected returns, and best position your portfolio to generate efficient cash flow when the time comes.
FREE FINANCIAL ASSESSMENT
With all the uncertainty and volatility in today’s economy, the time is now to take a thorough look at your finances. To accurately plan for your financial future, you must first know where you currently stand. For these reasons, our Success Team at Impact Advisors Group is offering a free financial assessment for both individuals and business owners. Request yours today!
This post was written and first distributed by Wendy J. Cook.
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RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
Four self-inflicted biases that knock a number of investors off-course are anchoring, blind spot, confirmation and familiarity bias.
Legendary economist Benjamin Graham once stated that ‘your own behavioral biases are often the greatest threat to your financial well-being.’
If you file tax returns separately AND are separated from your partner, colleges consider you a two-household family.
Take some time to map out how to pay for all four years before your student gets the bill for freshman year.