With the current low yields on fixed income securities, the financial media have produced many articles regarding high-dividend strategies. The following discusses two fundamental flaws with using these strategies as alternatives to either high-quality fixed income portfolios or to other equity strategies. While the financial media tout high-dividend strategies as alternatives to other prudent investment strategies — such as equity strategies or high-quality fixed income portfolios — there are several issues you should consider. First, a high-dividend strategy is far riskier than a high-quality fixed income approach, so comparing the two is like comparing apples to oranges. Second, it is well known within financial academia that a high-dividend strategy is essentially a value stock strategy, which is a strategy of buying companies that have low prices relative to earnings, book value, dividends or some other accounting metric. However, the high-dividend approach to a value stock strategy has historically had the lowest returns, and returns (meaning dividend payments plus capital appreciation) are ultimately what should matter.
The Risks of a High-Dividend Approach
The table below illustrates the historical differences in risks between a high-dividend equity strategy and a high-quality fixed income approach for the period of 1952–2009. For the high-quality fixed income approach, we’ll use the returns of five-year Treasury notes.
|
High-Dividend |
Five-Year Treasury |
|
|
Lowest Annual Return |
–36.3% |
–5.1% |
|
Lowest Two-Year Total Return |
–39.7% |
–1.7% |
|
Lowest Three-Year Total Return |
–33.6% |
1.6% |
|
% of Years With Negative Returns |
24% |
14% |
|
Annual Volatility |
20.0% |
6.4% |
Sources: Dimensional Fund Advisors, Ken French
The increased risks of a high-dividend equity strategy compared with a high-quality fixed income approach are clear. For example, the lowest one-year return on the high-dividend strategy was
–36.3 percent, which occurred in 2008. This compares with –5.1 percent for the five-year Treasury strategy. So by no means do high dividends insulate you from the overall risk in the equity markets. It is also worth noting that the volatility of the high-dividend strategy was more than three times higher than the volatility of the five-year Treasury strategy. Our conclusion is that in no way should a high-dividend equity approach be considered a replacement for a high-quality fixed income portfolio.