Total Return - Capital Appreciation & Dividend/Income

[Midpack]

Nothing new - but it's very easy to look at market indexes, NAVs, stock prices, etc. - but not always as easy to see the contribution of dividend income, interest, etc. from those holdings, and therefore the relative importance of each.

My holdings still largely favor (tax managed) capital appreciation over dividends from my end of career days of higher tax brackets 2 years ago - when controlling timing of gains/losses was more important than it is today as a retiree. Even so, in the past 5 years 60% of our total return has been from capital appreciation and 40% from dividend income.

I suspect many here have much higher dividend income relative to capital appreciation, and I expect I will slowly increase our holdings to provide more dividend income.

I considered a poll, but couldn't come up with meaningful options...so FWIW.

 

[pb4uski]

I'm the inverse - 63% from interest and dividends and 37% from realized gains, capital gain distributions and unrealized appreciation - for 5 years ended 6/30/2013. Per a Quicken Investment Activity report for the period.

 

[jebmke]

Honestly, I don't know. I suppose I could figure it out but I just don't know what I would do with the info. I know I wouldn't do anything different since all our holdings are in line with our allocation goals.

 

[NW-Bound]

As I invested for total return, I did not pay much attention to dividend yield. I tried to find stocks that I thought were undervalued to buy low, sell high, so I paid more attention to the bottom line. Dividends were nice, but I would have to add them up from multiple accounts, and that was too much work (the info was not needed for tax-deferred accounts anyway).

However, recently I have paid more attention to dividends. Luckily, Quicken provides a very nice summary for me. I now know my dividend and interest incomes to the last penny in the last 12 months.

It works out to 2.46% for our entire portfolio (before and after tax), excluding my wife's 401k. The reason her 401k has to be excluded because the account custodian does not report dividend yield or cap gains. I guess there's no point as everything is reinvested inside to the same funds in that account.

The above 2.46% is a lot higher than I first expected, given that dividends from balanced funds that tend to be income-oriented are not that much higher. For reference, Wellesley currently yields 2.50% and Wellington 2.22%. Perhaps my style of investing has drifted more than I realized.

And by the way, there was a past thread about dividend yield in 2010. See: http://www.early-retirement.org/forums/f28/what-does-your-portfolio-yield-these-days-50168.html.

PS. Quicken also says that in the last 12 months, I had a realized cap gain of 3.8%. That was mostly due to 2012 year-end trading to get the 0% cap gain tax for people with little earned income. That tax law turned out to be extended. Else, I might not have sold.

And about unrealized gains, I have mucho, but I won't tell. It comes and goes anyway. It is never a sure thing until it gets converted to cold cash, but then what do I do with that cash to get any return?

 

[Animorph]

The reason her 401k has to be excluded because the account custodian does not report dividend yield or cap gains. I guess there's no point as everything is reinvested inside to the same funds in that account.

I like it when I don't have to deal with distributions within DW's 401k. I'm a total return investor. But it must cause some consternation for someone trying to live on just dividends when a 401k fund automatically reinvests and never documents dividends or other distributions. A real world example of total return investing with "make your own dividend"!

 

[siamond]

Not too sure to understand why one should care whether a market return comes from dividends or from capital appreciation.

Trying to line up dividends with your annual needs seems a challenge & headache, and I don't quite see why bother.

Returns are returns. Just automatically re-invest your dividends (online broker accounts usually allow you to do that), and reverse-balance the whole thing once a year to get your withdrawal of the year... Simple?

What am I missing?

 

[NW-Bound]

The difference is that if an investor tries to live off dividends, he will have to choose among stocks that pay good dividends and restrict himself from growth stocks. It's a matter of investing philosophy.

There are studies that show stodgy stocks actually outperform volatile growth stocks that do not have long-lasting power. There is a lot of truth in it, and people who invest in non-dividend paying stocks have to keep closer watch on their holding. So many growth stocks are just flash-in-the-pan.

 

[Midpack]

Not too sure to understand why one should care whether a market return comes from dividends or from capital appreciation.

Trying to line up dividends with your annual needs seems a challenge & headache, and I don't quite see why bother.

Returns are returns. Just automatically re-invest your dividends (online broker accounts usually allow you to do that), and reverse-balance the whole thing once a year to get your withdrawal of the year... Simple?

What am I missing?

The difference is that if an investor tries to live off dividends, he will have to choose among stocks that pay good dividends and restrict himself from growth stocks. It's a matter of investing philosophy.

There are studies that show stodgy stocks actually outperform volatile growth stocks that do not have long-lasting power. There is a lot of truth in it, and people who invest in non-dividend paying stocks have to keep closer watch on their holding. So many growth stocks are just flash-in-the-pan.

Like the OP said to start "Nothing new..."

The other thing that [-]many[/-] some folks miss time and time again is they track market composites/indexes/benchmarks and mistakenly assume they represent total returns - and make ill-advised decisions as a result. Otherwise, you're not missing anything...

 

[siamond]

Hi Midpack, thanks for your answer. Agreed.

I suspect many here have much higher dividend income relative to capital appreciation, and I expect I will slowly increase our holdings to provide more dividend income.

Now this is the part of your first post I don't get. Why would you want to do that?

If total returns will decrease on average in the long run (e.g. because of globalization, global warming or whatever reason one might find to get worried), then I am not quite sure that dividends are any safer than capital appreciation. And if you want something more stable/steady, then isn't it more typical to change your stock/bond ratio?

 

[Midpack]

[-]I suspect many here have much higher dividend income relative to capital appreciation, and[/-] I expect I will slowly increase our holdings to provide more dividend income.

Now this is the part of your first post I don't get. Why would you want to do that?

If total returns will decrease on average in the long run (e.g. because of globalization, global warming or whatever reason one might find to get worried), then I am not quite sure that dividends are any safer than capital appreciation. And if you want something more stable/steady, then isn't it more typical to change your stock/bond ratio?

If taxes on long-term gains and dividend income remain at ZERO for those in 10% and 15% tax brackets I may not, but I'd be very surprised if that "windfall" continues indefinitely.

Then once again, there will be no escaping federal taxes on dividends in taxable accounts, you pay annually whether you spend, reinvest or whatever. So I want to control exactly when I take capital gains and/or losses for federal taxes. If I have to sell assets for withdrawals, I may not be able to legally minimize taxes. Some of it comes from being in a higher tax bracket when I was working...and controlling capital gains was crucial.

I haven't done anything yet, but if we reach a point where dividends don't provide enough to cover withdrawals and the tax advantages return, I would consider changing our allocation to provide more dividend income.

 

[siamond]

I haven't done anything yet, but if we reach a point where dividends don't provide enough to cover withdrawals and the tax advantages return, I would consider changing our allocation to provide more dividend income.

Ok, I understand your reasoning now. Essentially a desire to optimize taxes.

But the cure might be worse than the problem... By skewing your portfolio towards dividends-making companies, you might impact your long-term returns (and your AA diversification) in non desirable ways.

Anyhoo, thanks for the explanation.

 

[clifp]

I am sort of the opposite I can tell you almost within a thousand bucks what my dividends have been for the last 5 years, but have no clue what the realized capital gains would be without pouring through my tax returns.

 

[urn2bfree]

If taxes on long-term gains and dividend income remain at ZERO for those in 10% and 15% tax brackets I may not, but I'd be very surprised if that "windfall" continues indefinitely.

Then once again, there will be no escaping federal taxes on dividends in taxable accounts, you pay annually whether you spend, reinvest or whatever. So I want to control exactly when I take capital gains and/or losses for federal taxes. If I have to sell assets for withdrawals, I may not be able to legally minimize taxes. Some of it comes from being in a higher tax bracket when I was working...and controlling capital gains was crucial.

I haven't done anything yet, but if we reach a point where dividends don't provide enough to cover withdrawals and the tax advantages return, I would consider changing our allocation to provide more dividend income.

+1
Dividend returns in taxable accounts automatically create potentially taxable income. With enough dividends one could end up moving out of a tax bracket with ZERO percent tax liability right into 15%. With cap gains as the main source a significant part of the cash you withdraw is likely to be return of principle and not at all taxable.
Example: if I need $100,000 and all of it is generated by dividends, I may have to withdraw $117,647 which after I pay 15% to the Feds leaves me my $100,000. But suppose instead dividends only generate half..$50,000. I then sell to get the next $50000 via capital gains. Even if I have been extraordinarily successful as an investor and have no losses to offset the gains,
and gained 100% on my Investment, that $50,000 only consists of $25,000 taxable gains, along with $25,000 return of principle. In fact I could sell assets that had appreciated a whopping 400% and still only take out my $100,000 and not owe ANY federal taxes (for simple math I have ignored state taxes) but you can see this consideration has saved me over $17,000 a year.

 

[mathjak107]

The difference is that if an investor tries to live off dividends, he will have to choose among stocks that pay good dividends and restrict himself from growth stocks. It's a matter of investing philosophy.

There are studies that show stodgy stocks actually outperform volatile growth stocks that do not have long-lasting power. There is a lot of truth in it, and people who invest in non-dividend paying stocks have to keep closer watch on their holding. So many growth stocks are just flash-in-the-pan.

and how many origonal dividend paying dow stocks are still around today ? in fact i can rattle off so many biggies that burned investors right from the s&p 500.

i am a total return man myself,. couldn't give a hoot about dividend yield, never did.

i want a safe ,consistant reliable income stream and never count on spending dividends directly.

to much variation when they are cut or suspended at the worst times leaving shortfalls in income.

i know lots do it but i like a nice ole consistant buck of cash that does not vary by market action.

 

[modhatter]

I know people with ample assets tend to scorn dividend stocks and people who view them as a good part of their income stream not to be sophisticated investors, and certainly not concerned with tax implications.

However, for people who are retired and very much need their income stream from their portfolio, and don't have $3,000,000 saved, their most pressing need is not always going to be tax consequences, or whether their portfolio grows 6% or 9%. They "need" income and are very much afraid of losing their principal if a bad sequence of down or sideway years occurs, devastating their portfolio. For these people being in "stable" proven dividend paying stocks, offers them the same income irregardless of the above scenario, so they are still able to derive the needed income while waiting for the market to recover, and they are not forced to sell their shares in a down market to obtain the money needed for their living expenses.

Now, I am not arguing for one approach being superior or inferior, or which would portfolio will conceivably be bigger in the end. I think that tag could only be applied depending on which direction the portfolio went over the course of several years in retirement and how much you have in it. If it is a reasonably good bull market, Total Return should win. If it is a prolonged Bear market, Dividend or Income should win for the retiree in most cases, and still be able to keep up with inflation.

So discounting it in it's entirety is in my mind is a little short sighted. I think most people would prefer to not have to concern themselves with dividends or interest to survive their retirement, and would prefer to chose only those funds that they felt held the highest possible future appreciation and diversification.

Many people in retirement have counted on income from both their bond funds and their dividend stocks to live on. And we see what bonds are yielding today. So you think you should be leaving a message for people to sell their Dividend stocks and load up on Bond Funds now?

If you haven't heard, many people in retirement now are desperate for income. CD's pay squat, bonds pay squat and are not at an entry point at the moment. Reits are way overvalued, and are paying squat now.

Maybe, it's because of the name of this board "Early Retirement" that we have so many one sided views on this. Obviously a lot of people who navigated to this site were fortunate enough to be able to entertain early retirement. But remember, there are lots of others who just Googled the word "retirement" and found this site too.

When giving advise, people need to keep this in mind I think, and realize that others may not be walking in the same shoes as you do.

I think fear is at an all time high right now with retirees (the one's without the mega millions) The economy is not on very strong footing, with the looming out of control deficit, constant loss of jobs to overseas countries, fear of cuts to social security, medicare, loss of pensions, and global deficits around the world.

This fear translates also to fear of loss in the stock market over the ensuing years (especially when you consider it's current evaluation levels)
So taking all this into consideration, a solid dividend income stream might look like the best option for some people at this time. So perhaps, a little more open mindedness might be appropriate when you don't know who you are talking to. And possibly pointing out the pro's and cons of both approaches would be nice. Just a thought

 

[Lsbcal]

...(snip)...
However, for people who are retired and very much need their income stream from their portfolio, and don't have $3,000,000 saved, their most pressing need is not always going to be tax consequences, or whether their portfolio grows 6% or 9%. They "need" income and are very much afraid of losing their principal if a bad sequence of down or sideway years occurs, devastating their portfolio. For these people being in "stable" proven dividend paying stocks, offers them the same income irregardless of the above scenario, so they are still able to derive the needed income while waiting for the market to recover, and they are not forced to sell their shares in a down market to obtain the money needed for their living expenses.
...

I have sort of heard of this type of investment approach before. But I've never seen a study that showed how this was a really great all weather method. We do have long term track records for Wellington (back to the 1920's). Maybe Wellesley? But I'm guessing that their dividend yield is not enough for an investor in the above category. I'm skeptical that very high dividend yields are maintained in extremely stressful multi-year bear markets.

Are there any studies that show such an approach gives superior down market performance at the expense of up market performance? It should cover several really bad bear multi-year markets.

 

[Animorph]

I have sort of heard of this type of investment approach before. But I've never seen a study that showed how this was a really great all weather method. We do have long term track records for Wellington (back to the 1920's). Maybe Wellesley? But I'm guessing that their dividend yield is not enough for an investor in the above category. I'm skeptical that very high dividend yields are maintained in extremely stressful multi-year bear markets.

Are there any studies that show such an approach gives superior down market performance at the expense of up market performance? It should cover several really bad bear multi-year markets.

Morningstar had an article about how dividends held up in the last market dip. It was significantly better than equities in general, for example if you were just taking 3% of the portfolio value each year. Down a little more than 20% off the top of my very crappy memory. Not ideal, but better than 50% down. I don't know how well they recovered.

I don't see why less wealthy would have to use dividend investing. It just seems older and more conservative, in the sense of sticking with what has worked before. Total return is relatively new. Setting up a revocable trust in 2001 the language was that the surviving spouse would be able to use the "income" from the trust but not the principal. Not exactly a plan for total returns there.

Any of the target retirement funds would come close to total return, though they will be fairly conservative in retirement. They are not necessarily designed to supply only dividend income in retirement. They should be quite usable at any income level with very little effort.

 

[modhatter]

You are correct, that during a long sustained bear market, some dividends are cut entirely, and some just reduced. I was not advocating depending on the highest yielding dividends, as these are the most risky as a rule and will generally be cut in bad markets. But there are others that have achieved a constant record over very long time periods in bear markets.

There are 15 to 20 or so that fit into this category that yield maybe 3% that have had good performance over decades. The S&P 500 yields about 2% now. So people selectively purchase these stocks, and add a few others in the mix that they trade out periodically, as well as some utility & mlps, stocks to boost income. They then can add a little bit of small value to the mix to boost growth, and when interest rates are normal, the bond mix helps also with the income. There are lots of books and statistics on the subject.

You will never achieve high growth, but it can get you through the tough years.

 

[haha]

Rich people have been living on dividends and interest too for centuries. In modern times, dividends have been more dependable. If you just go out and buy the highest yielding stocks, or pay high prices, you will not be successful. But the slightest bit of prior investigation would help you to avoid that.

I cannot invest without an eye toward total return, since after all money is money. Dividends are a steadying and calming influence for the portfolio manager.

Ha

 

[pb4uski]

I know people with ample assets tend to scorn dividend stocks ...

Perhaps you know such people, but I don't. I think the smart money know that dividends are an important component of total return.

...I cannot invest without an eye toward total return, since after all money is money. ...

This seems contradictory to me. If money is money, then $1 from dividends is no different then $1 of realized appreciation, so total return should be right up your alley.

 

[haha]

Perhaps you know such people, but I don't. I think the smart money know that dividends are an important component of total return.



This seems contradictory to me. If money is money, then $1 from dividends is no different then $1 of realized appreciation, so total return should be right up your alley.

Things can be subtle, and as I mentioned to some other guy, everyone is not supposed to evaluate the world in the same way.

Ha

 

[modhatter]

No, I don't mean dividends are scorned, just the philosophy of dividend investing. Individuals who seek a portfolio that will render a greater slant towards dividends than a portfolio that is constructed without regard to dividends. My original criticism was that many people like the "sleep factor" more than the highest gain factor, and should not be dismissed for their choice. Doesn't matter if it's new school, or old school. People heavily invested dividend stocks and income stocks fared much better in the downturn and went on to enjoy stellar returns on the way up. In fact income stocks became the darling of the market.

And statements like this, I will never understand:

Not too sure to understand why one should care whether a market return comes from dividends or from capital appreciation.

Trying to line up dividends with your annual needs seems a challenge & headache, and I don't quite see why bother.

Returns are returns. Just automatically re-invest your dividends (online broker accounts usually allow you to do that), and reverse-balance the whole thing once a year to get your withdrawal of the year... Simple?

What am I missing?

You are saying there is no difference in pulling that dollar out of your dividend sweep account in a down market to selling shares in a down market to give you the needed dollars? Is that what you are saying? This is something that I can't understand when people say this. I understand your primes, but some times the primes can fall short. Also, it was my understanding we were talking about retirement and living off our assets, not accumulating them. I agree reinvesting dividends is always the better way to go when you can.

 

[pb4uski]

Seems to me you are picking nits on a distinction without much of a difference, and I tend to have a bit of a value tilt (see post #2). Look at the 1,3,5 and 10 year value of $10,000 of the Vanguard Value Index and Growth Index funds and the return for the periods are similar and the patterns are also similar. The Value Index fund and an SEC yield of 2.41% and the Growth Index fund has an SEC yield of 1.38%.

 

[Lsbcal]

If we look at the Vanguard Value Index (VIVAX) we can see the contribution of income here: https://personal.vanguard.com/us/funds/snapshot?FundId=0006&FundIntExt=INT#tab=1a

From 1998 through 2012 the income component varied between 1.4% to 3.7%. All this is very nice and positive. But the cap gains varied from -38% to +29%. A wild ride.

I wish it were possible to make equities a smooth ride but I fear that is part of the package ... volatility. They don't call it the equity risk premium for nothing.

 

[jebmke]

Seems to me you are picking nits on a distinction without much of a difference, and I tend to have a bit of a value tilt (see post #2). Look at the 1,3,5 and 10 year value of $10,000 of the Vanguard Value Index and Growth Index funds and the return for the periods are similar and the patterns are also similar. The Value Index fund and an SEC yield of 2.41% and the Growth Index fund has an SEC yield of 1.38%.

Since inception (2000), Value Index has outperformed (which is what FF would predict). Even that period is fairly short, just under 13 years. Our holdings have been tilted to SV and MV since the mid-80s, very heavily until recently. Long periods with tracking error can be a bit unnerving.