Answers to
Practical Questions
Be Thankful for the Humble Dividend
Equity returns are provided by capital appreciation (when stock prices go up) and dividends. Most people are focused on the former, but the later can really help an investor’s mind survive a Bear attack. The underappreciated dividend has two important characteristics:
The first characteristic is that dividends from large-capitalization, well-diversified ETFs that have a minimum of five years of trading history (like those used in TheAnswerIs.ca Model Portfolio) will go down significantly less than the unit values of that ETF portfolio. The price of an ETF can decline 20% to 50% during a Bear attack. However, while the dividend portion of the distributions from a large-capitalization, well-diversified ETF with a minimum of five years of trading history may decline, the dividends typically decline substantially less than the unit price.
Collecting this ETF dividend income means an investor is getting paid to wait for the Bear to get tired and move off. The unit values of an ETF portfolio will rise back to their prior level, and then continue to rise to new highs years later.
The second characteristic becomes more evident if one thinks about dividends like the shoes that were being coveted. If one continues to make monthly purchases of ETFs as the Bear attack rages on, not only will they be buying the new shoes (dividends) at a discount, but they will be getting better pairs of shoes.
For example, let’s say before the Bear attack, an ETF had a dividend of $0.90 per unit and the unit price was $30. The resulting dividend yield was 3.0%.
Now let’s say a medium-size Bear attacks and causes the ETF price to drop 35% to $19.50, (i.e., $30 x* .65% = $19.50). IF the dividend stays the same, the new dividend yield is a very attractive 4.6% (i.e., $90 ÷ $19.50). Even if the dividend gets cut by, say, 10% because of a recessionary environment, the dividend yield will still be 4.15%, (i.e., ($0.90 x .9) ÷ ($30 x .65) = 4.15%).
This is a key concept that helps an investor meet their retirement planning goals.
For example, in retirement, if an investor wants their investment portfolio to pay them an annual income of $30,000 in perpetuity, and dividend yields are 3%, then that investor needs to save $1,000,000 in their portfolio by the time they retire (i.e., $30,000 ÷ .03 = $1,000,000).
Now for the COOL part.
If dividend yields rise from 3% to 4.6%, the investor now only needs to save $652,174 to achieve the same $30,000 of income in perpetuity (i.e., $30,000 ÷ 4.6% = $652,174). Conversely, if an investor was able to accumulate their original $1,000,000 target nest egg while dividend yields were 4.6%, they would now obtain an annual income of $46,000 in perpetuity, which is 53% higher (i.e., ($46,000 – $30,000) ÷ $30,000) than the original $30,000 target.
It is very true, Bears are scary. They may cause an investor to taste that little bit of spit-up in the back of their throat. But, Stock Market Bears create opportunities for a good investor. The prudent investor refuses to sell in a downturn and continues to make their regular ETFs purchases. Smart investors are “buying when everyone else is selling.”
“We don’t have to be smarter than the rest. We have to be more disciplined than the rest.”
– Warren Buffett