golden opportunity to see which investment strategies work

Sheer with friend

The best thing about a ferocious and sudden bear market is that it provides us all with a golden opportunity to see which investment strategies work… and which do not. And by “not working,” I simply mean that the portfolio doesn’t offer higher returns with less risk than a cheap and basic alternative such as an S&P 500 index fund.

If you are like me, you gravitate towards the idea of owning companies with lengthy histories of consistently rising dividends. These seem like they must be lower-risk companies than their counterparts, having stood the test of time and generously lined the pockets of their eager shareholders. If the dividend growth is fairly consistent, that’s a nice steady stream of income the investor can reinvest for compound returns (and what works better than compounding over the long term)? In theory, dividend growth sounds like a great investment approach. Right?

There’s just a little wee bit of a problem. A fly in the ointment, as it were. The proverbial monkey wrench caught in the gears. Dividend growth investing does not (necessarily) work.

Dig this. Using a portfolio backtesting tool available on, I constructed an equal-weight portfolio comprised of 5 widely held dividend growth ETFs: the iShares Select Dividend ETF (DVY), the SPDR S&P Dividend ETF (SDY), the Vanguard Dividend Appreciation ETF (VIG) and its higher-yielding counterpart Vanguard High Dividend Yield ETF (VYM), and the Schwab US Dividend Equity ETF (SCHD). These are five examples of passive funds with varying (often intersecting) selection criteria for dividend growth stocks. Assuming you rebalance the holdings annually and reinvest every dividend, how would your performance compare against the S&P 500 from November 2011 (when SCHD first started trading) through today? Answer: Horribly.

The dividend growth ETF portfolio produces annualized returns of 8.58% against the 10.41% annualized returns of the S&P 500. What’s worse, the maximum portfolio drawdown for the dividend growth portfolio exceeds the maximum drawdown for the S&P 500 by over 5%.

So there we have it, folks. Lower returns, more risk and, of course, more fees.

Results do not improve much by adding in the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) and running the simulation from November 2013 (when NOBL first started trading) through today. Frankly, the results for this dividend growth ETF portfolio stink. Annualized returns of 5.3% versus the 7.34% annualized returns on the S&P 500.

And the maximum portfolio drawdown exceeds that of the S&P 500 by over 4%. Mix equal parts lower returns and higher downside risk, sprinkle with a generous dash of fees, put in the oven for 7 years and presto! A figurative overcooked turkey of an investment approach to discreetly sneak off your plate, fold into a napkin, slide under the dining room table and feed to the dog.

The worst-performing dividend growth ETF of the entire dismal lot is DVY. If we are to remove DVY from the model, the results are not much improved. The dividend growth ETF portfolio still underperforms the S&P 500 woefully (to the tune of 1.66% per year) and experiences meaningfully higher drawdowns of over 3% in extra losses.

So, should we all now conclude that dividend growth investing is dead? Is it now obvious that the Dividend Achievers and Dividend Champions are simply bad companies that make bad investments? No! The problem with dividend growth ETFs may have less to do with which stocks these funds hold and more with how the funds hold them. Or more precisely, how these ETFs do not hold their investments. What I mean is that each of these funds rebalances holdings regularly and has a policy of removing companies that fail to pay (or in some cases, raise) dividends. In other words, these funds are constantly doing things. It turns out that there is a fundamental difference between long-term buy-and-hold investing versus investing with static investment selection and retention criteria over a long period. You see that difference clear as a bell in each of the charts above.

And you see the difference even clearer when you compare these results to those of a certain dividend growth investor who does not, as a rule, do much of anything besides sucking his own thumb. For as it just so happens, my lovely readers, I own many of the very same stocks that these dividend growth ETFs own – plus a few shares that no dividend growth ETF owns (such as Alphabet (GOOG), which pays no dividend but one fine day most certainly will). About the most I ever do is collect dividends, spend what I need and then reinvest the savings into more shares of whichever company looks like the best deal at the time. Sometimes (but rarely) I add new positions (such as Bank of America (BAC), Exxon (XOM), Valero (VLO) and Mondelez (MDLZ) – all of which I bought last week and this week). And sometimes I do the occasional trade here and there (like buying AGNC Investment Corp. (AGNC) and Annaly Capital Management (NLY) late last week and selling the shares this week). Sometimes, if I own a company that messes up its financials (like Kraft Heinz (KHC) did a while back) or that lies and cheats customers (like Wells Fargo (WFC) did a few years ago), I sell the stock at any price and never, ever buy it again. Investment activity in my house is the exception and not the norm.

Another difference between my version of dividend growth investing and the versions used by the various dividend growth ETFs is that I consider many factors besides dividend growth before I buy a company. For example, I look at credit ratings on Moody’, and the company’s profit margins and free cash flow. I sample products and visit stores, where applicable. I basically use any and all criteria that somehow convince me that the business is well-managed and sells exceptional products or services. My overwhelming obsession is to own high-quality businesses, and I figure that if I do that effectively, then the dividend growth will eventually come on its own.

I ran a backtest on my portfolio of individual stocks using Here are the results:

The annualized rate of return is a bit less than 2%, better than the S&P 500 but nearly 4% per year higher than the dividend growth ETF portfolio. The maximum drawdown on my portfolio slightly exceeds the maximum drawdown for the S&P 500 by around 1%, but is about 3% less than the maximum drawdown for the dividend growth ETF portfolio. The annualized alpha on my portfolio clocks in at 2.52% versus the S&P 500.

To my mind, dividend growth investing can absolutely deliver higher returns than the S&P 500 with modestly higher risk, but only if it’s done with a genuine buy-and-hold approach that no dividend growth ETF offers. And it maybe requires you maybe be a bit more flexible and less rigid and narrow with your investment selection criteria.

I don’t mind sharing my full portfolio holdings and allocations (you already know that my portfolio holdings and investment approach tell you virtually nothing about how you should invest or what you should or should not invest in). I just think that total transparency is a good practice and policy whenever you’re writing about investments.


Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long each and every position you see in the attached charts, and have no other financial positions besides those. I cannot guarantee the accuracy of the results produced with the PortfolioVisualizer tool, which of course means that I cannot guarantee the accuracy of anything else about this article, either. Not that it matters, for this article is not investment advice, nor am I an investment advisor. I could drone on and on to just really drive that point home, but honestly I think you’re probably smart enough to figure out the rest all on your own.


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