Sunday, December 10, 2023

Late In The Game: Dividends Are Cautionary?

A couple of months ago, there were debates in some discussion groups on whether reliance on dividends as an investment and/or retirement strategy is (picking the appropriate word) cautionary. The side which provided the caution cited several reasons, such as the companies may reduce the amount or change their dividend policies, and the obsession with yield over everything else clouded the judgement of total returns of a security, to name a few.

While we are primarily dividend investors, we agree with some of the points highlighted by the cautionary side. However, as with most issues in general, it depends on which facet we are looking at and the approaches to it, and it is mainly a case of theoretical/academic versus operational/practicality viewpoints.


While I would not be going through all the arguments, let us look at the two points that were brought up between the two camps, and my takes on them.


#1: The Fallacy Of Dividends

The first point was put forth in a paper1, which stated that many investors view capital gains and dividends as separate variables rather as the same thing, i.e., total returns, and dividends are seen as free money. However, the share prices of the dividend-paying companies would reduce by the amount of dividends paid out.


Addressing the latter, it is true to an extent and this can be observed. The drop in accordance with the dividend payout is very pronounced on dividend ex-dates, ceteris paribus. However, we should not look at this alone as there are many factors dictating the rise and fall of the price of a counter. Also, there were instances where prices dropped after dividends were announced and rose after ex-dividend.


On total returns, I have been emphasizing they are made up of capital gains plus income (dividends), so as investors we need to fit this equation in our heads. Going a bit further, unlike capital gains where we need to sell the counter to realize it, the income component is realized all the time. The liquidity of the dividends gained could be deployed on other more productive securities and not just on the same one, thus overall on a portfolio level there could be more gains collectively than what the fallacy holds for individuals.


#2: Safe Withdrawal Rate Vs Dividends For Retirement


This next point which saw a lot of comments for and against is the safe withdrawal rate (SWR) versus dividend streams for retirement income. In summary, on one side SWR posited a drawdown of a certain percentage from one’s investment portfolio to provide an income, while the other supported using dividends only as an income stream.


SWR was formulated by a financial adviser named William Bengen in the 1990s2, and from his analysis a 4% withdrawal rate was the sweet spot, though a higher or lower withdrawal rate could be employed depending on the comfort levels and income required for a retiree, and the prevalent market conditions on how the asset classes behave. In the eBook, I had provided a basic example of the 4% withdrawal rate at play3.


Despite the arguments, the main underpinning reason against SWR and the proposition for dividends was that the latter was more easily understood and to operationalize. People can see how much dividends they are getting and adjust their expectations of the amounts that could be obtained in the near future. For SWR, one would have to calculate the withdrawal amount based on perceived statistics such as inflation rates, and at the same time to determine which asset class(es) to drawdown the capital from, a daunting task for a retiree who did not have financial know-how.


Overall, I would like to bring additional opinions with regards to this dichotomy. Firstly, on the dividend stream, I had written a post on a way to manage this method (mentioned here), which it mitigates current year income by using last year’s and adjust one’s lifestyle accordingly. Secondly, there can be a compromise between the two, by employing the SWR with the withdrawal coming from dividends first and the shortfall from liquidating some of the capital.


Thirdly, and most important, is that we do not just rely on just one portfolio. Depending on one’s age, there are CPF Life, Supplementary Retirement Scheme (SRS, if one had started with investments), rental (for multiple-property owners or those who could spare a room or two), etc. in providing the streams, dubbed the income bucket strategy, which warranted a whole new write-up. Making the drawdown more robust, portfolio diversification by time (mentioned here)  may dampen the sequence of returns risk.


In conclusion, regardless of whether dividends are good or bad, in managing one’s portfolio, I would like to give this one-liner modified from a famous saying by Thomas Jefferson, the third President of the United States: 


“The price of (financial) freedom is eternal (portfolio) vigilance.”



1 – Hartzmark, Samuel M. and Solomon, David H. The Dividend Disconnect. 30 Jul 2018. (accessed 7 Dec 2023)


2 – Bengen, William P. Determining Withdrawal Rates Using Historical Data. Financial Planning Association. Oct 1994. (accessed 7 Dec 2023)


3 – The Bedokian Portfolio (2nd Ed), p142-143

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