The following is a guest post by Squiggle over at www.financesquiggle.com. To read further on investing strategies, see his post on the best way to invest $10,000. Enjoy!
Talking to most stock investors, you’ll hear of attempts to maximize returns or beat the index. Those who strictly adhere to the Efficient Market Hypothesis (EMH) contend that the stock market is too competitive and that stock prices reflect all readily available information, making consistently above average returns impossible. Hand-in-hand with EMH supporters, Random Walk Theory proponents will tell you stock prices are simply too random for you to achieve above average returns in the long-run.
The research is mixed, however. Many studies show that certain types of stocks tend to have better returns. Below is a summary of some of the evidence supporting investing in stocks with high dividend yields.
Research Highlights in Favor of High Dividend Yields
Tweedy, Browne Company LLC published a fascinating paper strongly in favor of investing in stocks with high dividend yields. One study in the U.K found that from 1955 to 1988, the decile of stocks with the highest dividend yields had a compound annual return of 19.3% compared to 13.0% for the index.
O’Shaughnessy Asset Management has a similar paper supporting high dividend yields. In a US study from 1930 to 2011, the top decile of dividend yield stocks had a compound annual return of 11.6% vs. 10.2% for all US stocks. Even more exciting, from 1990 to 2011, the top decile of dividend yield stocks worldwide had a compound annual return of 14.8% vs. 6.9% for the index of all stocks. The top decile beat the benchmark in 100% of the 5 year rolling periods throughout.
Credit Suisse published another promising paper on the topic, with an added twist. The firm examined the returns in 12 countries and reached the same conclusion that high dividend yields produce superior returns. They also examined a second variable of payout ratio (the percentage of net income paid out as dividends). In the majority of the countries studied, the combination of high yield, low payout ratio produced the best returns (in a few cases high yield, high payout won). For example, in the United States from 1990 through 2008, the high dividend yield, low payout ratio portfolio had the highest compound annual return of 15.4%, while the S%P 500 returned 8.4% annually.
Recent Performance of High Dividend Yield Funds
Despite the research, high dividend yield funds haven’t been fairing well in the last several years. Here are three examples vs. the S&P 500 since their inception.
From March 20th, 2007 to December 16th, 2013 the S&P 500 beat the Vanguard High Dividend Yield Index Fund (VHDYX) 28.8% to 16.57%.
From October 19, 2007 to December 16th, 2013, the S&P 500 beat Tweedy, Browne’s Worldwide High Dividend Yield Value Fund (TBHDX) 14.69% to 10.47%.
From September 17, 2010 to December 16, 2010, the S&P 500 beat the O’Shaughnessy Enhanced Dividend Fund (OFDIX) 61.0% to 23.32%.
Unfortunately, high dividend yield funds have not been performing well in the last several years. However, the research in favor of stocks with high dividend yields is robust. Those with high dividend yields tend to outperform those with low dividend yields handily (especially those with a low payout ratio). As with most strategies that have shown outperformance over the long run, there are periods of underperformance.
Despite this recent lag, decades of sound research make this strategy worthwhile as part of your portfolio for the long-term. Diversification is one of the cornerstones of personal finance, so it’s best to dedicate only a fraction of your investments to high dividend yield stocks. Additionally, research shows that funds with low fees outperform those with higher fees over long periods. Accordingly, dedicating part of your portfolio to the Vanguard High Dividend Yield ETF (VYM), with a low expense ratio of 0.10%, is an excellent investment choice.
How about you all? Do you think it is possible to beat the market returns by investing in high yield dividend stocks or a dividend-based index fund? Share your experiences by commenting below!
Patel, Pankaj N., Souheang Yao, and Ryan Carlson. “Quantitative Analysis: Global Dividend Strategy.” Credit Suisse, 23 Jan. 2009. Web.
“The High Dividend Yield Return Advantage.” Tweedy, Browne Company LLC, 2007. Web. 16 Dec. 2013.
Viswanathan, Ashvin. “Dividend Yield vs. Dividend Growth.” O’Shaughnessy Asset Management, 20 Sept. 2012. Web. 16 Dec. 2013.