Seven Pitfalls Dividend Investors Should Avoid
by Charles Rotblut | October 07, 2021
Thanks to everyone who joined us last week to make our Investor Conference 360 a success. Those of you who attended can access replays on the conference website. If you weren’t able to join us live for the investor conference, you can still purchase full video replays of EVERY session.
At the conference, former Vanguard CEO Jack Brennan suggested dividend stocks as an income-producing alternative to bonds in the current low-interest-rate environment. But he cautioned that dividend stocks do come with higher levels of volatility.
We agree with him. Dividend-paying stocks are inflation fighters. There are many with yields equal to or greater than what you can find among intermediate-term and long-term Treasuries. Like all other stocks, the prices of dividend payers will experience more upward and downward volatility than bond prices will. The extent to which dividend-paying stocks are volatile depends not only on the market but also on company-specific issues.
AAII Dividend Investing editor Derek Hageman recently listed several dividend investing pitfalls. I’m summarizing his list here as it will help you avoid unwanted headaches while seeking out sources of portfolio income.
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Focus Solely on Yield—When people start investing in dividend stocks, they are typically drawn to high-yield stocks. There is no specific threshold for “too high”; however, a stock’s five-year average range, its industry median and the absolute market yield provide a gauge. A dividend yield that is too high can signal perceptions of a weak outlook for a given company, an unsustainable dividend payment or both.
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Buy a Stock Only Because It’s Cheap—One of Warren Buffett’s most notable quotes about value investing is, “Price is what you pay. Value is what you get.” Investing in stocks is not just about buying stocks at a cheap price and selling them at a higher price. Knowing the difference between a cheap stock and one that is a good value is often the difference between making and losing money. For AAII Dividend Investing, we seek to find undervalued stocks, as determined by the dividend yield, but then use other qualifying metrics to determine the sustainability of the dividend payment and dividend growth in the future.
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Focus on Current More Than Future Dividends—While a stock’s current dividend is relevant, it’s the potential for higher dividends in the future that is exciting. Therefore, it is critical to examine a company’s recent and long-term trend in raising dividends and any significant developments that may impact its ability to continue generating free cash flow in the future.
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Hold a Poor-Performing Stock Too Long—Investors tend to “fall in love” with a holding and then make excuses or develop reasons why it may not be time to sell. Investors also tend to hold out for too long in hopes that the stock’s price will rebound, and they will be able to recoup their losses. Having pre-established sell rules limits risk, decreases the chance of potential losses and reduces the potential for behavioral biases to interfere with an investment strategy.
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Skip Your Homework—Conducting a minimum level of due diligence on a company allows you to know what you own, what you are buying and selling and why you are doing so.
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Follow a Dividend Capture Strategy—Dividend capture requires buying a stock just before the ex-dividend date to collect the dividend, then selling it right after the dividend is paid. Markets are reasonably efficient, so the share price is usually reduced to reflect the dividend payout, resulting in an investor typically breaking even after taxes are taken into consideration.
- Fail to Monitor Your Stocks and the Market—While you don’t need to obsess over them by checking your brokerage account 10 times a day, it is good to keep tabs on your investments to ensure they remain suitable for your portfolio.
- The Wall Street Journal’s Spencer Jakab offered additional suggestions for avoiding mistakes made by ineffective investors.
- One way of boosting portfolio returns is to reinvest the dividend payments, as investment manager Lowell Miller demonstrated.
- Derek Hageman compares and contrasts high yield and high dividend growth strategies in the new October AAII Journal.
- Also in this month’s AAII Journal, I give suggestions for how to effectively monitor your portfolio.
- We are launching two new and exciting AAII member benefits. The first is our PRISM Wealth-Building Academy—an interactive experience designed to help you create your own personal wealth-building plan. The PRISM Academy can be found in the new AAII Community. Tune into Wednesday’s webinar to find out about these just-released enhancements to your AAII membership.
- Finally, AAII assistant editor Anine Sus unveiled a new blog today, My Investing Discoveries. If you’re new to investing or know someone who is, I recommend reading it.
AAII Sentiment Survey
The results from the latest AAII Sentiment Survey show neutral sentiment jumping back above its historical average. In addition, the number of investors describing their outlook for stocks as “bullish” fell to an unusually low level.
Bullish sentiment, expectations that stock prices will rise over the next six months, decreased 2.7 percentage points to 25.5%. This is the fourth consecutive week that bullish sentiment is below the historical average of 38.0%.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, increased by 6.6 percentage points to 37.7%. This jump puts neutral sentiment above its historical average of 31.5% for the first time in three weeks.
Bearish sentiment, expectations that stock prices will fall over the next six months, decreased by 3.9 percentage points to 36.8%. This week is the fourth consecutive week and the ninth time in the last 10 weeks that bearish sentiment is above the historical average of 30.5%.
As noted above, bullish sentiment is now at an unusually low level (more than one standard deviation below its historical average). Historically, unusually low levels of optimism have been followed by both above-average and above-median six- and 12-month returns for the S&P 500 index. Bearish sentiment is back within its typical range after having risen to an unusually high level last week.
The return to normalcy from the coronavirus pandemic, monetary and fiscal stimulus and inflationary pressures are influencing individual investors’ outlook for stocks. Other factors include earnings, valuations and the Biden administration’s initiatives.
In this week’s special question, we asked AAII members to share whether the recent back-and-forth about raising the debt ceiling has impacted their short-term outlook on stocks.
More than half of respondents (56%) say that they are indifferent to the debate about raising the debt ceiling. Many respondents indicate that it is just political noise and that they are confident it will be resolved. Furthermore, the political infighting doesn’t seem to impact these respondents’ investing strategies. This compares to 33% of respondents who say they have a negative outlook resulting from the debt-ceiling talks, citing the potential for a crash in the near to medium-term future. About 7% of responses express a positive outlook.
Here is a sampling of the responses:
- “I am not a short-term investor, so I just consider this noise over the long term. It has not affected my style of investing.”
- “Over the short term it is a negative, over the long term no impact.”
- “I expect a short-term drop like we are seeing now, followed by a market increase. Good buying opportunity.”
Bullish: 25.5%, down 2.7 points
Neutral: 37.7%, up 6.6 points
Bearish: 36.8%, down 3.9 points
Bullish: 38.0%
Neutral: 31.5%
Bearish: 30.5%
See more Sentiment Survey results.
AAII Asset Allocation Survey
Individual investors lightened their exposure to equities relative to the past three months while still maintaining a historically high allocation to stocks and stock funds. The September AAII Allocation Survey also shows a small rebound in preference for less volatile assets.
Stock and stock fund allocations decreased by one percentage point to 70.2%. September marked the seventh consecutive month that equity allocations were at or above 70%. September was also the 16th consecutive month that AAII members’ exposure to equities was above the historical average of 61.0%.
Bond and bond fund allocations rose by 0.3 percentage points to 15.5%. Even with the increase, fixed-income exposure stayed below its historical average of 16.0% for the seventh consecutive month.
Cash allocations increased by 0.6 percentage points to 14.3%. Cash allocations were last higher in May 2021 (15.1%). September was the 17th consecutive month that cash allocations have been below their historical average of 23.0%.
Equity allocations remain at an unusually high level. Though our weekly Sentiment Survey showed the level of optimism staying below 30% during most of September, individual investors largely maintained their stock and stock fund investments.
- Stocks and Stock Funds: 70.2%, down 0.9 percentage points
- Bonds and Bond Funds: 15.5%, up 0.3 percentage points
- Cash: 14.3%, up 0.6 percentage points
- Stocks: 31.7%, down 0.6 percentage points
- Stocks Funds: 38.5%, down 0.3 percentage points
- Bonds: 2.4%, down 0.0 percentage points
- Bond Funds: 13.1%, up 0.4 percentage points
- Stocks/Stock Funds: 61.5%
- Bonds/Bond Funds: 16.0%
- Cash: 22.5%
Take the Asset Allocation Survey.
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