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Dividend Funds and Investing
Old 03-25-2014, 08:00 AM   #1
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Dividend Funds and Investing

Can someone explain to me how investments such as Vanguard Dividend Index Funds work and how they should be approached for early investing?

Originally I had the idea to purchase stocks in a basket of industries to build myself a sort of "pension" over the next 30 years or so until FIRE since the work world is moving away from them. Ideally buying stocks at lower prices today and hoping to have attractive yields and growth through reinvesting dividends later. Since this portion of my investing is outside my tax advantage accounts I figured getting the capital tax rate on the dividends was the best I could do.

Fast forward 2 years and now I'm retinking the strategy. I don't mind monitoring a dozen stocks or so but am now thinking how much easier getting into dividend funds would be. Not only would it help hedge some risk from individual stocks but I feel like it would allow for a much more... set it and forget it approach. I like investing but I also feel like once the bachelor life ends I'll have less free time to do financial research.

I guess the ultimate question here is how do you feel about Dividend funds, and how should someone with 25-30 years of working left approach them? I am personally interested in obtaining some sort of yearly income stream for retirement to help balance out my Roth IRA and 401k which are both focused on growth with the eventual shift towards bonds later. Since I am working now I don't need that income stream today, but I like having a plan to work towards to get that stream ready for a long time in the (hopefully) somewhat near future. Should I be putting my earmarked dividend money into growth funds and then moving that balance into dividend funds upon FIRE, or is the dividend funds worth investing now and sticking with that all the way? I'm really not sure how these dividend funds calculate their dividends each year and what makes the amount go up or down. At least with stock dividends they typically go up each year and that's easier to understand
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Old 03-25-2014, 08:41 AM   #2
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These funds, like all mutual funds, is simply a proportional ownership in a portfolio that is professionally managed. It would be more diversified (and therefore perhaps somewhat less volatile) than the individual stock portfolio you are creating because it has hundreds of stock rather than tens of stocks. For example, Dividend Appreciation owns 146 stocks worth about $22.7 billion, so you would get your little sliver of the performance of that $22.7 billion portfolio. A dividend fund would just be tilted towards stocks that pay higher than average dividends.

If I has 25-30 years until retirement I would probably go 70/30 Total Stock and Total International Stock. These are index funds that essentially track the total domestic US stock market and the international stock market and are very low cost.

From there it would be easy to add a dividend tilt if you want to by adding the Dividend Appreciation fund and reducing Total Stock. For example, you might go 50% Total Stock, 20% Dividend Appreciation and 30% Total International.

Individual stocks can be fun, but IMO to do it right is a lot of work and at your age you probably have better things to do that spending nights reading 10ks.
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Old 03-25-2014, 10:37 AM   #3
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Here is a nice thread that compares dividend fund/stock investing to "magic pants": Bogleheads • View topic - Dividends and the Magic Pants

If you believe in magic pants, then dividend fund investing is for you.
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Old 03-25-2014, 10:44 AM   #4
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I used to have a basket of dividend paying individual stocks. Since I use dividends and interest earned to pay for my expenses I had to keep up with when the dividends posted to my brokerage account so I could transfer the funds to my interest bearing credit union checking account. Each company paid their dividend on different days and it took a little time to keep track of.

So I sold those stocks, offsetting their gains with some other losses, and purchased the Vanguard High Dividend Yield ETF (VYM). It has a lower expense ratio than the Vanguard High Dividend Yield Index mutual fund (VHDYX) and there was no commission fee on either one. I like having the broader diversification of the ETF over the individual stocks and knowing when the quarterly dividend will be credited.
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Old 03-25-2014, 11:21 AM   #5
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Each individual stock lets you defer capital gains taxes until you choose to sell the holding. Hold it until retirement and it can be even better than a tIRA because you won't pay ordinary tax rates on the gains. With a fund, you lose that deferral and pay CG tax on whatever the fund manager decided to sell that year.
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Old 03-25-2014, 12:00 PM   #6
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Placing dividend producers in a taxable account can generate a tax drag, though if you have mainly qualified dividends it may not be terrible. Nonqualified dividends are taxed at your full income tax rate, not capital gains. During the accumulation phase you might do better keeping them in a tax deferred account. Foreign dividends with foreign taxes can be an exception, so you can claim the foreign tax credit.

Other than that, whatever generates the best total return. Dividends are a part of that.
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Old 03-25-2014, 12:42 PM   #7
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Thanks for the insight everyone. Yes I was only focused on qualified dividends for this stock basket to get the special tax rate. Keeping track of payments hasn't been an issue yet since the funds go right back into additional shares, plus I enjoy tracking everything via spreadsheets. I can see that getting annoying if I had 15 different pay days and having to move them all to a different account to actually spend them.

I feel like the constant stories of examples like Buffet buying KO years and years ago and now getting yields of >50% are clouding what's the best course of action for the future though so that's why I wanted to ask the ER experts!

Currently out of tax advantage accounts so really it's index vs individual stocks. I have time on my side but like everything else, luck and fortune tend to follow those with a plan
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Old 03-25-2014, 12:55 PM   #8
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Quote:
Originally Posted by LOL! View Post
Here is a nice thread that compares dividend fund/stock investing to "magic pants": Bogleheads • View topic - Dividends and the Magic Pants

If you believe in magic pants, then dividend fund investing is for you.
The magic pants was a comment about taking a dollar out of one pocket and showing it was still a dollar in the other, implication being paying a dividend doesn't change anything, in a way to demean anyone who believes dividend stocks outperfornm.

Then for real world "proof" a chart is posted for 21 year period between Vanguard Equity and Vanguard total market. That shows Vanguard Equity income outperforms Vanguard Total Market from 1992 10 K becoming 80K invested in dividend stocks instead of 73 K invested in total market. The magic pants crowd then derides that difference as insignificant, due to the 2000 tech boom failure, or higher risk profile for the dividend stocks since they include value stocks and value stocks have a higher risk profile.

There have been several long term studies that have shown that dividend stocks do offer better returns. Jeremy Siegel in 2005 had a study and their is this good one on dividends.

Most important though is having a strategy and sticking with it, dividend or no dividends.
http://www.tweedy.com/resources/libr...udyFUNDweb.pdf
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Old 03-26-2014, 09:04 AM   #9
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Originally Posted by Running_Man View Post
Then for real world "proof" a chart is posted for 21 year period between Vanguard Equity and Vanguard total market. That shows Vanguard Equity income outperforms Vanguard Total Market from 1992 10 K becoming 80K invested in dividend stocks instead of 73 K invested in total market. The magic pants crowd then derides that difference as insignificant, due to the 2000 tech boom failure, or higher risk profile for the dividend stocks since they include value stocks and value stocks have a higher risk profile.
The most compelling argument I see on bogleheads that dividends make no difference is that they don't appear in factor models where one is performing regressions to explain equity returns. In general, if an obvious variable like dividend (or dividend yield, etc) doesn't appear in a regression model as a predictor it typically means one of the following:

(1) The variable is irrelevant and has no explanatory power

(2) The variable is relevant but the effect size is to small to make it worthy of including in the model

(3) The variable is relevant but once we consider other variables, the marginal benefit is too small to include in the model.

(4) The model is misspecified so that the term doesn't appear as significant (but might be significant if the model had a different form).

In this case I think many on BH might argue that dividends are subsumed by the value factor (reason #3). #4 seems unlikely as a reason that dividends don't appear in the regression models given the amount of academic interest.


Quote:
There have been several long term studies that have shown that dividend stocks do offer better returns. Jeremy Siegel in 2005 had a study and their is this good one on dividends.
Are you referring to this paper: The Superior Risk and Return Characteristics of Dividend-Weighted Stock Portfolios, (with Jeremy D. Schwartz and Luciano Siracusano), WisdomTree Investments, March 2006, 63 pages?

I wasn't able to find an online copy but given the publication time-frame Siegel would be well aware of the various factor models to explain equity returns. Do you know what his argument would be against the idea that the existing factors (e.g. value and perhaps low beta) already encompass the information in dividends?
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