I came across this article late last week, and I thought it was an interesting jumping-off point for the Digest. The author contends that dividend investors often make three common mistakes: chasing yield, forgetting about total return, and not keeping track of their investments.
While somewhat basic, I believe the article raises a thought-provoking question about the habits of dividend investors and whether or not they make these specific mistakes, if they make them at all. I respect the author, but I feel like he oversimplifies the investing process and the thought and care that go into constructing a solid DGI portfolio.
However, we’re all human, and I know there have been lengthy discussions and articles posted here on Seeking Alpha about past investing mistakes. So maybe one (or more) of these three gaffes has tripped you up in the past, or perhaps another blunder the author didn’t consider in his short article. As Mike Nadel aptly puts it below: “Anyone can get ‘lost’ a little.” I think that’s true, no matter what type of investor you are.
That brings us to this week’s question: Are dividend investors guilty of chasing yield, forgetting about total return, and not keeping track of their investments? If so, why? If not, why not? Are there other “common mistakes” not mentioned here?
And the responses:
Some dividend investors are guilty of chasing yield. Some aren’t. It would be wild generalization to say all are. I know I have been guilty in the past. I bought LinnCo (NASDAQ:LNCO). I bought Prospect Capital (NASDAQ:PSEC). I bought Ensco (NYSE:ESV). I like to think I no longer do that because I have changed my focus to quality above all else.
Do dividend investors “forget” about total return? I’m not sure that’s how I would put it. Many — perhaps even most — focus on dividend growth, figuring if their holdings are reliable dividend growers it also will move the needle on total return. That’s how I feel, anyway.
I absolutely track my investments — but I’m mostly tracking the income stream. For me, it’s impossible to track my investments without at least knowing how the price movement is. Others say they can shut that out.
For me, the biggest mistake that any investor — not just those into DGI — can make is buying companies that are not in his or her “comfort zone.” It could involve investing in sectors he/she isn’t familiar with. It could involve following advice without doing enough research. Each of us must be true to himself or herself. Again, I don’t see this as being particular to any type of investing strategy. Anybody can get “lost” a little.
“Are dividend investors guilty of chasing yield?”
Some are, some are not. I have been guilty of that in the past, and will probably be guilty of (I hope less of) that in the future.
“forgetting about total return”
As you can tell from my recent article, I do not use total return, so I
can’t be “forgetting” about something that does not help me achieve my personal investing goals.“Are there other ‘common mistakes’ not mentioned here?”
Probably, but I doubt that “all DGI investors always make the same
mistakes.”
I believe any investor at one time, at least in the beginning, is guilty of “chasing HIGH yield” until they understand quality is paramount. High yield means getting paid for risk, in most cases. The yield will not continue if the company does not succeed.
The novice investor most likely doesn’t even know what that means. That could be an article in itself, since there are many high yield investors who do know which investments will produce HY with the BDCs , REITs and MLPs, and they can be good investments.
Yield chasing for quality, safety and increasing value is what I want. I remain guilty of that. The higher that yield, the better, but then some sacrifices in growth of the yield are forsaken. So a mix is also important, and throw in some growth stocks just for diversification. (I recently have done that.)
Total return is only achieved if you pretend you have sold your investment at that moment in time, which of course, has not been done, so why even bother with such a statistic? I like looking forward on FAST Graphs to see what my total return “could be,” but even that is a prediction and not true, especially so if you never sell. So, if you don’t sell, you only get the dividend, which we want to be constant and growing. I look at earnings to gauge my decision.
Time in all things, compounding of the dividend for 12-15 years in a stock can bring great returns in stock share numbers, which generate the income while you watch. If your time is running short, then you need more of the nice income producers (there are many choices) to meet those needs.
For anyone to say DGI investors don’t keep track of their investments is surprising to me. Everyone wants to know how their money is working for them. Even the worst investor around gets a statement. I think they most likely are in funds that have a manager, but they do read and question the bottom line.
The most “common” mistake is assuming what you hear or what you read actually is correct. Always do your due diligence and check and verify before getting into any investment.
I truly believe there is an over-emphasis on the current value of an investment, and IMO, price is merely the “market’s opinion.” I prefer to use the “herd’s opinion” instead of market price. I understand it in so many ways.
Value is how people are trained to think about both themselves and their ability to retire. Everyone wants to be valuable and thinks they “need a lot of money” to retire. They are busy with life, stick money in a 401k or mutual fund and consider themselves “invested.” Then, they check their statement to see the “value” and judge how they are “doing” with their saving/retirement. They want to be “wealthy” and are incessantly bombarded with the need to “save” an amount and not taught to invest. There is a big difference between saving and investing.
Truly wealthy people did not save up some amount. They invested wisely and usually took advantage of the “herd’s opinion” being wrong on a current or future cash flow. They had a knack for understanding that value, first and foremost, comes from cash flow. Cash flow is the foundation that supports value in the long run, but the “herd’s opinion” of the current and future cash flow is frankly too volatile to put much credence in for the short term, IMO.
You can call it P/E, P/FFO, or P/DGR. They all fluctuate far too much on the top side of that ratio. Those are great BUYING metrics and horrible selling metrics for long-term investing. Price still is the only metric they watch and judge. I truly believe obsessing over daily value and not understanding that an investment’s strength comes from the underlying cash flow is perhaps the biggest mistake investors make. Yes, the belief that cash flow is more important than price must be balanced by a realistic view of the eminent need to monetize that flow for some of life’s inevitable problems. Life is always a balance on almost every level, including money.
I understand the need to check value and that cash flow may need to be sold and monetized. It is a good way to be validated by the “herd’s opinion.” However, that need to be validated should be very limited to be a good investor. Investments are not savings, and, treating an investment like a savings is hugely dangerous to your investing success. By just being in the stock market, you should already realize you no longer have much control of value. The “herd’s opinion” changes for many reasons.
Can people make money at buying and selling? Of course, but that is not what I am talking about. Day traders can make money. Not retirees usually, of course. Can you just buy the highest yielding stock and get high payments until you die? Not usually. Both extreme strategies are horrific ideas for most Americans who are just now realizing they are not ready for what retirement really means — a steady stream of expenditures funded by your decisions early in life on your personal cash flow. Notice I keep coming back to cash flow over value.
DVK has just done an exemplary job of explaining why a % payout of a value is a terrible idea unless you have a tremendous amount of money. Most people in America do not have a tremendous amount of money, and unfortunately, no one teaches them the mindset of investing.
Since the equation for yield has the income they pay on top of the ratio, it is a much better way to look at things, and it makes the outcome far less volatile. Price change affects yield far less precisely because price is on the bottom. It is a better way to look at investing, IMO. Understanding basic math helps. A ratio with the volatile number on top is a far more volatile result.
Value has virtually nothing to do with it. Value or capital is merely a tool to grow the income we live off of. I ask people “would you rather have a bunch of golden eggs or the goose that lays them?” IMO, owning the goose and learning how to increase its output of eggs is a MUCH better way of thinking about retirement than trying to guess the amount of eggs you will need or boosting the goose’s value so you can sell it. That is the core takeaway for me on DVK’s excellent articles, although I use that knowledge very differently.
He concentrates on DGR for DGI. I am an Income GR investor that prefers leverage and yield spread far more, however, we both explain it is the cash flow generated that people should be looking to understand as the key to retiring. I try to explain with my comments that investors should first take a hard look at what they want out of stock investing.
The dangers of constantly trying to buy and sell far outweigh the reward for me. I look at cash flow as the primary way to decide how well we are doing instead of the “herd’s opinion.” I am a lousy market timer. I spend a lot of time understanding and knowing the dangers to each of my cash flow generator’s cash flow. If I want a new source of cash flow, I prefer to use my existing cash flow to add into the flock, which adds more diversity. It is precisely because I understand what drives the flow that I can scoff at changes in price that are not directly related to the health of my geese and their egg output.
Because I concentrate on high egg production, I can make the hard decisions when eggs falter on one goose. However, it is always based on egg production, not herd opinion. A slight slowdown may signal a real problem and a need to sell. It may also mean the herd is just panicking and gives me the ability to more than get my production back up.
I also am a strong believer in diversity. This only really means lots of “different types of geese, eating different things to grow and stored in different places.” Again, if a stock has a variable input cost/margins or currency fluctuations that make the cash flow fluctuate, I don’t have to “panic sell.”
I invest in stocks to have different cash flow generators. I have changed nothing, except I am able to have a larger variety of generators and can apply new methods to enhance “golden egg” production. “Egg production” is still my goal, not what I can sell the geese for. Retirement is about your “eggs,” not what the “herd” will buy your geese for.
Total Return is using two metrics and one is not real. TR is a fine metric if you are focused on price as your core way of achieving your goals. TR is a terrible metric if you are focused on the cash flow of your retirement.
A cash flow-based retirement needs to focus on the underlying cash flows of what is being generated and it is highly dangerous to use today’s pricing to sell, great for buying.
In a sentence, cash flow is the verb and value is the noun. In an equation, cash flow is the operator and price is the integer.
They all interact – knowing what you want is the key.
Now it’s your turn to weigh in. What do you think? Are these three mistakes — chasing yield, forgetting total return, and not keeping tabs on their investments — the “most common” for dividend investors? Are there others that get in the way of achieving your investment goals?
And now, on to the week’s Dividends & Income news and analysis:
A quick shout-out to long-time commenters RoseNose (linked above) and Ted Fischer, who both submitted their first articles this week. For those who’ve been hesitant to join the contributor crowd, Rose tells me it’s been an amazing and rewarding experience. Congratulations, and let’s keep those contributor converts coming!
The Melting Pot Portfolio: First Inning by Tyler Leonard
ConocoPhillips: A Surprise Dividend Hike and A Harsh Downgrade For Linn Energy by Albert Alfonso
Prospect Capital: Reconciling Different Points Of View by Long Player
The Real Difference Between Total Return Investing And DGI by Ted Fischer
Periodic Table Of Dividend Champions – Which Champions Have The Best Combinations Of Yield And DGR? by David Van Knapp
RoseNose’s Adventure To Reacquire Shares Of 3M Company… And Buy Now!by RoseNose
Retirement Strategy: There Are Dividend Aristocrats That May Be Bad For Your Health by Regarded Solutions
Chesapeake’s Dividend Cut – Food For Thought For Yield Investors by Richard Zeits
Durability Test: Realty Income by Brad Thomas
Buy And Hold Vs. Selling Shares: A Study Of Capital Preservation Methods Within A Dividend Growth Portfolio by Nicholas Ward
Patience, Cash And Dividend Growth Investing by Mike Nadel
This week’s big stories: Chesapeake’s divvy cut, CYS (NYSE:CYS) and Hatteras (NYSE:HTS) report weak quarters, dividend investors are eyeing an opportunity in Cummins (NYSE:CMI), and more mREIT earnings are on the way.