Investing for dividends

Is it a good idea to invest for dividends?

There is no doubt that one of the best ways to buy stocks for the long-term is searching for companies that pay good dividends, and specially those which dividends grow over time; a very important factor, since it seems that just by buying those stocks with better dividends is not enough to beat the market.

One of the reasons that have made this strategy of investing in dividends so popular is the fact that Warren Buffett used companies with strong dividend profile.

However, Buffett strategy is not a pure dividends strategy.

In fact there is no really a method Buffett used to use.

His system was based on “value”, which is to say based on his good criteria.

Not everybody was so lucky to buy Coca Cola, Gilette or Johnsons at the right time and maintain them for so long.

Invest in dividends
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Some other bought Eastman Kodak or General Motors unfortunately. Two companies which were very popular more than 40 years ago, and with good dividends, by the way.

Although not everybody has the contacts and the influence Buffett had, without which I doubt his results would have been the same.

Investing in dividends

The majority of investors who try will discover that it is very difficult to get to Buffett’s level, and the majority of them will even struggle to beat the S&P500.

In a very interesting article about this issue in the web IFA, it is explained that the funds based on dividends are not always the best, which is far being the case.

Sometimes dividends are good and sometimes are not so much.

Depending on what cycle or time, dividends will have a better or worse alpha.

For instance, the author of the IFA’s article explains us that now General Motors would not be in anyone’s portfolio, but long time ago it was in a lot of people portfolios based on dividends.

Eventually we know how General Motors ended.

Investing for divididens strategy

What is known is that it is not always easy to find the stocks that can beat the market as Buffett.

We will probably find good stocks and very bad stocks.

To defend his thesis the author of IFA’s article compares some funds of his company, in particular the fund of big companies (IFALC), another of “Value” companies (IFALV), and Vanguard growing dividends fund (VDIGX), which exist since some decades.

The comparison tries to go as long as far back in time, and using different periods of time, like 5 or 10 years.

Here we have the different returns in different periods.

5 years result

  • VDG: 16,5%
  • IFALC: 18%
  • IFALV: 21%

10 years result

  • VDG: 9%
  • IFALC: 7,3%
  • IFALV: 9%

15 years result

  • VDG: 5,2%
  • IFALC: 4,6%
  • IFALV: 8%

20 years result

  • VDG: 7,7%
  • IFALC: 9%
  • IFALV: 10,4%
  5 years 10 years 15 years 20 years
VDG 16.5 9 5.2 7.7
IFALC 18 7.3 4.6 9
IFALV 21 9 8 10.4

As we can see the returns vary depending on the time frame chosen.

For the shortest time frames, the Vanguard’s dividend index behaves quite well.

However, when choosing the more than 20 years statistics, including many bull and bear markets, it is the worst of the three funds analyzed.

In general, the fund “Value” was the best.

The Vanguard dividend Index was the best for low volatility, though.

From this point of view, we could consider that a dividend type of fund like this is quite secure in the short run, but it will not be the best for return in the long run.

This matches the well known fact that returns and risk are strongly correlated in the stock markets.

Therefore, seeing this case we cannot say that investing in stocks with good dividends has to be the best option, not necessarily better than other strategies choosing growth or value stocks.

Evidently, growth stocks will tend to grow more in periods of bull stock markets and dividend stocks will do better in moments of risk.

If you are seeking for more security and less volatility, then dividend strategies are probably the best for you.

If you really want more “security” you should buy treasury bonds.

However, despite what this study said I am sure that most of those who do long term strategies based on dividends think that they can beat the market.

Only the long term will dictate who is right or wrong.

Not everybody will be able to emulate Warren Buffett, neither will everybody beat the S&P500.

Some will, when choosing some “key stocks”, and some will not.

Albeit, in general we can say that investing in dividends is a good strategy with a low risk than looking for exotic stocks, and also gives good payments in the long run.