Dividend Strategies: Missed Opportunities?

Disclaimer: This is not financial advice or a recommendation!

The article “When Chasing More Dividends Leaves You With Less“ from the Wall Street Journal by Jason Zweig (who, by the way, wrote the commentary for The Intelligent Investor) sheds light on the appeal and associated risks of dividend strategies. Investors who focus on high dividend yields often hope for a steady income stream, especially in times of low interest rates. However, as the article points out, chasing high dividends can ultimately reduce long-term returns. The problem arises when investors blindly flock to funds that offer exceptionally high dividend yields.

As an example, Zweig mentions the Global X SuperDividend ETF, which offers a dividend yield of 11%. However, this ETF has lost over 70% of its value since its inception in 2011. Despite the high payouts, the total return remained negative, meaning the dividend is essentially paid from the investor’s own capital, with a little extra loss on top. This highlights the risk that companies with high dividends may have financial problems and could lose value over the long term.

Zweig therefore recommends exercising caution and avoiding funds with extremely high dividend yields, as these often come with higher volatility and the potential for capital loss. In fact, he even advises against ETFs promising dividend yields above 4%.

Helmut Jonen had also read the WSJ article and posted about it, which caused a stir in the community. He mentions the Vanguard FTSE All-World High-Dividend Yield, which he is not concerned about. The Van Eck Morningstar Developed Markets is mentioned critically, as well as the iShares STOXX Global Select Dividend 100. I had just looked into the latter, and the result was that almost all of the 100 stocks were also included in the FTSE All-World.

So, what do the numbers actually look like?

Now, let’s take a closer look at the performance, specifically comparing the four mentioned ETFs to a MSCI World ETF with reinvested dividends. The following charts show the performance of these ETFs from July 2016 to September 2024, highlighting the difference between performance calculations with and without dividend reinvestment. The eight-year period provides a solid basis for assessing the long-term development of these funds.

In the next chart, we will focus on the performance of the ETFs without dividend reinvestment, meaning based purely on price movement (capital appreciation).

Here, dividend funds perform significantly weaker:

• VanEck Morningstar Developed Markets Dividend Leaders ETF: +54.96%. Without dividends, the fund shows only a moderate capital appreciation.
• Vanguard FTSE All-World High Dividend Yield UCITS ETF: +45.40%. Again, significantly weaker without considering dividends.
• iShares STOXX Global Select Dividend 100 UCITS ETF: +12.20%. This highlights that the performance heavily depends on the dividends.
• MSCI World ETF: +155.13%. Dividends are reinvested here, though not all companies in this index pay a dividend.

With dividends, the picture improves somewhat:

This chart shows the performance of the ETFs with dividends reinvested, which provides a more realistic view of the total return:

• MSCI World ETF: +155.13%, no change here, as dividends are automatically reinvested.
• VanEck Morningstar Developed Markets Dividend Leaders ETF: +120.53%, a significant improvement compared to the performance without dividends.
• Vanguard FTSE All-World High Dividend Yield UCITS ETF: +92.92%, also showing solid performance thanks to dividend reinvestment.
• iShares STOXX Global Select Dividend 100 UCITS ETF: +65.13%, the lowest but still an improved return compared to the non-dividend reinvested scenario. These ETFs are no longer in my portfolio.

So, dividend ETFs indeed have a lower return than the MSCI World ETF, right? Not quite so simple. In theory, dividends could also be reinvested, which would significantly improve the performance of the dividend ETFs. The MSCI World ETF already benefits strongly from the automatic reinvestment of dividends, which leads to a higher total return. If investors were to manually reinvest the dividends from distributing dividend ETFs, some funds might even compete with the MSCI World ETF or surpass it in certain market phases. The compounding effect from reinvested dividends would be a key driver here.

However, there are a few considerations to keep in mind:

1. Taxes: In Germany, dividends are taxed, even for thesaurierenden ETFs (accumulating ETFs), but in a different way. This means the compounding effect is slightly reduced due to tax on dividends, which could influence the total returns.
2. Income Generation: The underlying assumption in this analysis is that the investor wants to live off the dividends. In this case, the approach may change depending on how dividends are used (reinvested vs. taken as income). The tax on dividends, in particular, can reduce the amount available for reinvestment or income.
3. Rebalancing Costs: Not addressed or examined here is the question of how often the ETFs—especially those with only 100 holdings—adjust their positions. To maintain high dividend yields, the fund must constantly reallocate its holdings when a company no longer provides the expected high dividends. This rebalancing comes with additional costs (such as trading fees), which the investor may not immediately see. These costs can eat into the returns and should be factored into any long-term comparison with a fund like the MSCI World, which may experience less frequent adjustments.

Conclusion:

While dividend ETFs show lower returns than the MSCI World ETF in these comparisons, reinvesting dividends—whether automatically or manually—could improve their performance. The key factors influencing the overall returns include the tax treatment of dividends, the compounding effect, and the rebalancing costs for high-dividend funds. Thus, the total return potential of dividend ETFs could approach or even exceed that of the MSCI World ETF, depending on these dynamics.

Advantages and Disadvantages of a Dividend Strategy

Advantages:

1. Regular Cash Flow:• One major advantage of dividend strategies is the more or less constant income stream, which is particularly attractive for retirees. Even in market downturns, the dividend payment provides financial support without having to sell stocks or ETFs at a loss.
2. Lower Volatility:• Companies that pay regular dividends are often large, established firms with stable cash flows. This can reduce the volatility of a portfolio, as these companies are less affected by large price fluctuations. However, dividend ETFs have also been impacted by market swings caused by events like the Corona crisis.
3. Inflation Protection:• Dividends can rise over time, offering some protection against inflation. This is especially beneficial in times of low interest rates or high inflation.

Disadvantages:

1. Lower Overall Return:• As seen in the charts, dividend funds often perform worse than growth-oriented funds. The lack of reinvestment of profits into the company diminishes long-term growth potential, a theory that Graham, among others, questioned.
2. Tax Disadvantages:• Dividends are taxed immediately in many countries, while capital gains are taxed only upon sale. This leads to an immediate tax burden and can reduce the compound interest effect over time.
3. Focus on Mature Companies:• Dividend funds tend to invest in mature companies that have stable but low growth rates. High-growth companies, which reinvest their profits and pay little or no dividends, often offer greater price appreciation potential.
4. Possible Dividend Cuts:• Dividends are not guaranteed. Companies can reduce or suspend their dividend payments at any time, which can lead to income loss. This is particularly risky during times of crisis when companies need liquidity, and in fact, some dividend ETFs have slightly reduced their payouts.

A Mixed Strategy: Balance Between Income and Growth

A mixed strategy that includes both dividend stocks and growth stocks can offer a good balance between income and long-term growth. This so-called core-satellite strategy includes a core of broadly diversified ETFs, supplemented by specialized positions. By diversifying between dividend and growth stocks, portfolio risk is spread. In weak market phases, dividend stocks may provide more stability, while growth stocks can enhance performance in bull markets. Here, we assume that the dividend ETFs are not merely focused on high yields but also have substance. The assumption is also that not all wealth needs to generate dividend income, but a portion can continue to grow.

The allocation depends on individual goals and risk tolerance. Here are some examples:

1. Conservative Portfolio: 60-70% dividend stocks/ETFs, 20-30% growth stocks/ETFs, 10% bonds• Goal: Stable income, lower volatility, capital preservation.
2. Balanced Portfolio: 40-50% dividend stocks/ETFs, 40-50% growth stocks/ETFs, 0-10% bonds• Goal: Balance between income and growth, moderate volatility.
3. Growth-Oriented Portfolio: 20-30% dividend stocks/ETFs, 60-70% growth stocks/ETFs, 0-10% bonds• Goal: Maximum growth potential, higher volatility.

Conclusion

Dividend strategies offer benefits for investors seeking a more or less regular income and more stability in their portfolio. However, dividend funds generally lag behind broadly diversified growth funds like the MSCI World in terms of price performance, especially if dividends are not reinvested. A mixed strategy that includes both dividend and growth stocks can provide a sensible balance between income streams and long-term value growth. The correct allocation depends on individual goals and risk tolerance, and regular portfolio review is necessary to ensure an optimal balance.