Dividend Growth And Income Investing Vs. Total Return: A Battle For The Mind

by: Ramon Vredeling

Aren’t we investors a strange bunch? We all know that we generally make better investment decisions when we completely separate emotions from our thought process and rely merely on our competence and experience. It’s just a shame that it usually proves rather difficult to achieve this goal to perfection.

I have followed the recent SeekingAlpha discussions on the pro’s and con’s of certain investment strategies with great interest, as I always believe you can learn greatly from proven industry veterans. However, I was increasingly surprised about the one-sidedness of certain arguments against lifelong dividend and/or income investing. The highest possible "Total Return" was stated to be the key. To achieve this superior result a more "diversified" portfolio would be required, although no subsequent proven portfolio result was provided for comparison with the one's provided by several DG (dividend growth)-investors.

Now, I’ll be the first to admit that although having increasingly shifted to large-cap holdings during the last 12-18 months, I don’t have a set dividend requirement. I mostly look at aspects like company results, relative valuation, management and competitiveness. I own telecoms, Oil and other commodity related business partly for dividend income to reinvest, but not necessarily. You don’t buy a Glencore (OTCPK:GLCNF) or Apple (NASDAQ:AAPL) for dividend. You buy because it was or is a good investment at a certain level, suited to one’s particular risk profile.

Risk profile, that’s what I’ve been missing in the comments and articles of the "Total Return" pundits. Some seem to completely disregard the fundamental issue of psychology of the average investor and the emotional investing associated with this.

I agree that individuals with years or even decades of experience in the securities industry, sparring over who has the superior method, are mostly skilled enough to abide by certain rules: buy low, sell high; continuously assess valuation and company fundamentals; form an investment thesis beforehand and stick to it; and don't let emotion lead your investing (as we are all wrong part of the time).

However, many investors, even professionals, naturally start to waiver when portfolio losses occur to the extent of Q1 2009 or Q2-Q3 2011. It’s a natural tendency to remember recent events better. The effect of this is clear, investors start focusing on the bad news in the media; financial scandals, corruption claims, political rhetoric, deficits, sovereign debt crisis, and forget that over the longer term the stock market has still been the best way to grow your money.

On the other side, while we’re in the midst of a bubble, the reality that bubbles will eventually burst when no longer supported by fundamentals starts to fade. We convince ourselves that our investments can’t fail and ignore information and/or opinions that don’t match our own, as we mostly look for confirmation.

And this is precisely why many retail investors are better off with pursuing a longer term dividend/income growth strategy compared to a total return strategy, which is often associated with a higher risk profile, more actively managed (possibly with higher transaction costs) and more opportunistic in nature.

The inherent problem for many (retail) investors is that the mind reacts roughly the same way to losing money as it does to pain. As pain is something we are built to avoid, we also instinctively try to avoid any potential for losing money. This sounds like a good thing, as our decision making tries to produce positive results. However, what also happens is that we instinctively try to avoid situations which could potentially lead to a feeling of lose/pain, even if the odds are greatly in our favor. This basically means we have to overcome our natural tendency to not invest at the precise times the market is providing us rare opportunities that will likely lead to a positive return on investment.

If you were to provide 10 retail investors with a set of different investment options and strategy the majority will certainly choose for the lower risk profile, even if the total returns over 20-30 years may prove to be less. The reason? You can never fully remove emotion from the equation.

People simply "feel" better about their holdings when the portfolio shows less overall volatility, a proven characteristic with large-cap companies that sport an established dividend history on a reasonable pay-out ratio. They also "feel" better when they see a steady stream of (dividend or coupon) income coming in, especially when the macro-economic climate is bad. These emotions convince investors to stick with their investments through the ups and downs of the stock market as long as the underlying investment thesis is still valid. After all, without sufficient time we’re no longer talking about actual investing, but merely about speculating on short term price movements.

For people invested in the stock market, the pain experienced when in the midst of a correction or bear market causes many to sell at the wrong moment. They will subsequently miss out on the market rebound, when all the while the market still has a proven track record over longer periods of time. If a strategy based on growing income from (re)investment and increasing dividends can prevent some investors from only investing when the market is going down and selling at the wrong times, I for one think it’s a strategy worth ample consideration.

As stated on previous occasions, I personally feel a combination of both strategies has proven best suited for me during the last couple of years, learning, adjusting and fine-tuning when required and based on prevailing market conditions at the time. As I already mentioned them before, I can name some of the companies currently in portfolio: Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), Teva (NYSE:TEVA), Novartis (NYSE:NVS), Transocean (NYSE:RIG), Seadrill (NYSE:SDRL), Heckmann (HEK), Intek (NASDAQ:INTC), Apple, Terra Nova (NYSEARCA:TTT), Glencore, Arcelor-Mittal (NYSE:MT), China Mobil (NYSE:CHL), China Unicom (NYSE:CHU), Telefonica (NYSE:TEF), Vodafone (NASDAQ:VOD), ING (NYSE:ING), China Petroleum and Chemical (NYSE:SNP), PetroChina (NYSE:PTR), BP (NYSE:BP), Royal Dutch (Koninklijke Nederlandse) Shell (NYSE:RDS.A), VALE (NYSE:VALE).

Some were bought based on (future) growth, some (also) with dividends in mind for reinvestment, some for anticipated valuation retracement, some for the short-medium term, some as long term holdings, some more opportunistic then others, but all in accordance with my desired risk profile. I guess that’s the key. To be content with your investments and to be able to sleep well at night, regardless what Mr. Market is doing in terms of pricing at the time. I still remember Ayrton Senna’s advertisement for TAG Heuer in the ‘90’s: “Success – It’s A Mind Game” ... It certainly is!