Response To 'Should You Build A Portfolio Of Dividend Stocks?'

by: David Van Knapp


A commenter responded to a question by writing a blog post.

The blog post asks 10 questions about whether someone should build a portfolio of dividend stocks.

I respond to the questions.

In a recent comment stream on an article about myths in dividend growth investing, I asked Placebo Investment Advice (PIA) the following:

You comment a lot on these articles. Why is it so important to you to criticize DG investing and the goals of DG investors? I'm curious. Why not write positive articles about what you believe in?

A few days later, PIA responded with the following:

In a comment above, Mr. Van Knapp asked me to write an article. I've actually written a few articles in the last month, though they're available only by clicking my Profile and then clicking Blog Posts. In fact, I just wrote an article, "Should You Build A Portfolio Of Dividend Growth Stocks?", available on Seeking Alpha at this link: Enjoy.

I read PIA's blog and considered the questions that he asked there. I decided to respond in this article for a couple of reasons. First, the original article engaged a lot of readers, with close to 400 comments so far, so I thought that readers might wish to see how this discussion proceeds.

Second, I thought that some of PIA's questions were off target, like he was asking the wrong questions. So what I have done here is reproduce his questions (in italics), offer rewrites (in bold), and then supply some discussion.

As a side note, I think that much of this discussion applies to all investment strategies, not just dividend growth investing. Underneath PIA's questions seems to be an unspoken belief that self-directed investors are making a mistake simply by being self-directed.

1. Are you confident you'll be more successful than most investors if you put your mind to the task?

Rewrite: Are you confident you'll be a successful investor if you put your mind to the task?

My recent article that PIA commented on was titled Dividend Growth Investing Myths 21-25. Since 2012, I have been cataloging myths about dividend growth investing. The recent article was the fifth in the series. There are lots of myths.

With his first question, PIA perpetuates Myth #22. While I stated that myth as "To succeed at investing, you must beat the market," it really is about seeing investing as a competition that must be won.

In discussing the myth, I said, "Much of investing punditry and advertising revolves around the idea that investing is about competing: Competing with indexes, benchmarks, other investors, or yourself."

Placebo's first question asks if you are confident about beating most other investors. That's the wrong focus. If you set goals for yourself, they are really your only target. Whether other investors do better than you at meeting their goals is irrelevant.

There is no need to compete with or beat anybody. The competition aspect is just distracting; it is noise.

2. Do you have plenty of spare cash and free time? Examples: a retiree with a pension, a part-time worker living rent-free with parents, a divorcee with a large cash settlement.

Rewrite: Do you have the time and interest to learn about investing and handle your own money?

First, I have no idea why "plenty of spare cash" comes into the discussion. Dividend growth investing is simply a strategy for investing, and it requires no more or less spare cash than any other kind of investing.

If "spare cash" was meant sarcastically, like dividend growth investors are just messing around with play money, that's a misdirection play (more noise). The only question about money for investing is whether you have money to invest. Its source (pension or divorce settlement for example) is irrelevant.

The free time part of Placebo's question is valid. Dividend growth investing, like any form of self-directed investing, takes a certain amount of time to learn the basics, evaluate opportunities, and manage your portfolio.

There is no way to generalize how much time it takes. For many, the investing process - education, security selection, and portfolio management - is one of the most enjoyable and rewarding things they have ever done. That is the way it has turned out for me and many others who write and comment here.

3. Are you more likely to be influenced by personal testimonials, anecdotes, and social media consensus than by hard-to-read academic research?

Rewrite: Are you a skilled reader and interpreter of information?

Investing, like many endeavors, requires you to process and evaluate information, then take action (or do nothing) based on your conclusions.

If you are a good reader, in my opinion, you can become a good investor. By "good reader," I mean that you can read and understand sources of normal difficulty. Some information in the field will be beyond your abilities, but most of it is not.

I also mean that you have decent critical skills, including a healthy amount of skepticism. Interpretation is important. While sources can sometimes be categorized as to likely trustworthiness, far more important is your ability to be a critical reader: Separate baloney from serious information, recognize sales jobs even when they are presented as legitimate analysis, understand the difference between presumptions and conclusions, and so on.

Especially important is your ability to distinguish "noise," which is usually focused on shiny objects and the short term, from truly helpful information, which is focused on the long term.

The paper credentials of the writer in the final analysis don't matter much. I would much rather get information from individuals and sources I have identified as being generally knowledgeable and trustworthy than degreed individuals that from experience tend to write baloney.

4. Are you resentful of investment firm fees, including small fees such as a 0.05% annual fee to own an index fund.

Rewrite: Do you want to invest in a cost-effective way?

I hope that all self-directed investors answer this question Yes.

The question posed by PIA is too emotional. Price for a product is not or should not be an emotional issue. We all encounter price comparisons in our daily lives as consumers. Answering them is not a matter of letting our emotions take over.

Rather, answering a price question means that you simply make a value judgment. "Does this product offer sufficient value to me at the price being asked?"

Those of you who are familiar with my writings know that I always include a valuation assessment on particular stocks that I might be considering buying. Valuation helps determine the long-term returns that I am likely to experience.

It's the same way with brokerage fees, ETF expense ratios, advisor fees, and the like. Such products and services cost money, but they also present a value proposition to you. As the consumer, you can take it or leave it. It's as simple as that.

5. Do you believe that dividends paid to shareholders generally do not diminish the value of dividend-paying companies?

Rewrite: No change.

I am convinced that dividends do not permanently diminish the value of dividend-paying companies.

Standard finance theory holds that they do. I call that Myth #17. You can see my reasoning by clicking on that link.

6. Do you believe that individuals should be able to outperform an index fund because index funds contain bad stocks that can be avoided?

Rewrite: Do you think that picking your own stocks helps you avoid bad ones?

Assuming that, as a self-directed investor, you perform due diligence on the securities that you select, you should be able to avoid the worst stocks in the universe that you pick from.

"Badness" in a stock comes from two sources. First, the company itself may be an undesirable investment: Bad management, poor business model, secular headwinds, untenable financing, and the like.

Second, the stock may not be available at a desirable price. Buying stocks individually allows you to buy them only when they are well valued. It's not that the company is inherently "bad," but rather that its stock is unfavorably priced. Not all great companies are great investments. They can be bad investments when they are overvalued.

The part about outperforming an index fund is a red herring issue (more noise). Your goal is not to outperform an index, it is to meet your goals.

7. Do you enjoy do-it-yourself projects without concern for whether your time and labor save money compared to hiring a professional?

Rewrite: Do you enjoy do-it-yourself investing, and do you believe that you can bring more value to your results compared to hiring a professional?

At first, I was going to offer no rewrites to this question, but upon further review, it struck me that the phrase "without concern" was off base.

With my rewrite, the question no longer implies that you have no concern for the value of your time and labor, but rather that you (as a consumer of investment services) are making a value judgment.

The answer for me to the rewritten question is yes.

I enjoy self-directed investing. There's little question in my mind that I invest as well as, if not better, than a professional would, especially in light of my goals. The value judgment becomes even more pronounced when professional fees are accounted for.

Having said that, I can definitely see where someone might believe that the answer for them is no, with the outcome that they would hire a professional to help them with investing, up to and including turning control of their wealth over to a professional to manage.

Most of my friends fall into that category. I don't try to convert anybody. It's a personal decision. Most of my friends know what I do, and they occasionally ask for tips or viewpoints. But they all employ financial advisors.

That's fine with me. We all spend our money in ways that are suitable for ourselves. As I said in a comment recently, turning my money over to a professional to manage would be like screeching my fingernails on a chalkboard.

8. Do you believe the performance claims of bloggers and other individuals without seeing audited or rigorously authenticated evidence?

Rewrite: Do you think it is important to believe the performance claims of bloggers and other individuals without seeing audited or rigorously authenticated evidence?

I made the slight (but significant) change to the question in light of how I reacted to #3 above.

As I said there, I think it is important to be a critical reader and thinker when you are a self-directed investor. That is how you will be able to invest up to the level of your capabilities. A key skill is being able to distinguish baloney from well-reasoned thought and analysis.

Experience has taught me that baloney can come from highly credentialed sources while good thinking can come from bloggers and self-trained individuals. It is up to me to sort them out.

As a side note, I rarely care what performance claims are made in sources like Seeking Alpha. Obviously false or inflated claims naturally hurt the credibility of the writer, but good reasoning is where you find it.

As Buffett has said:

You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right - that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else. Source

9. Is it more important that you feel in control of your investments rather than to maximize or maintain wealth with less effort?

Rewrite: Do you want to understand and feel in control of your investments?

The original question sets up a false choice: That you must choose between feeling in control of your investments or maximizing or maintaining your wealth with less effort.

The rewritten question simply asks whether you want to feel in control of your investments. I think that is an important element in deciding whether to cede some or all control of your investing to an advisor.

I do like to feel in control, but that's not the only reason I am self-directed. I also enjoy the processes of learning about investing and investing myself.

Not only that, I enjoy writing articles about what I do and why I do it, plus interacting with other investors in the comment threads and private messages that I receive. And as stated earlier, I think that I get better results for my goals by doing it myself, especially when professional costs are factored in.

If I believed that I would need to cede control of my money to get better results even after all fees and expenses, that might give me pause. But I don't believe that, which is why I think the original question presents a false choice.

10. If you see a claim that dividend stocks have generated more returns than the U.S. stock market in the trailing 10- or 20-year period, would you be confident that the dividend stocks you select will outperform the market in the next 10- or 20-year period?

Rewrite: No change.

All investing is probabilistic. Investing is not a process bound by physical laws. That's why there is no field called Modern Portfolio Laws. It's Modern Portfolio Theory, and the reason is that nobody knows the future.

I do believe, however, that history rhymes, and that evidence about what has already happened often provides clues about what may happen in the future.

But 100% confidence? No way.

Of course, that applies to every strategy or theory of investing. None of them provides 100% confidence about what will happen in the future. There are no guarantees.

If the original question was meant to imply less than 100% confidence, then move the confidence level to whatever number you like. It's still applicable to every theory or strategy of investing.

Having said that, I believe that some approaches to investing have higher probabilities of success than others. As a self-directed investor, I am always looking for edges. I am not privy to inside information about any company, and I don't have access to more information than anyone else.

Most of my edges come from finding facts and intelligent reasoning, then interpreting information well in light of my own goals. Combining good analysis with the ability to keep your goals at the forefront of your thinking is a powerful combination.

I have more confidence in that than I would in turning my money over to any professional advisor that I have met yet.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.