Debunking dividend investing myths

Many investors in Asia are drawn to dividends, often seeing them as a straightforward path to income. While dividends are a component of investment returns, focusing solely on them can distract from the more crucial concept of total return. 

At Endowus, we advocate for a holistic view of your investments. Let's bust some common dividend myths and clarify what truly drives long-term wealth creation.

Myth 1: Dividends are “free money”

The reality: This is perhaps the most pervasive myth and a fundamental misconception. Dividends are not “extra” money; they are a component of a fund’s total return, similar to a slice of a pie. 

When a company pays a dividend, its share price typically adjusts downwards by an equivalent amount on the ex-dividend date because that cash has left the company. Your overall wealth simply changes form, from capital value to cash. "When a company chooses not to distribute dividends, it can reinvest its profits to fuel future growth, potentially leading to capital appreciation for shareholders.

Focusing on dividends as separate “income” can mislead you into believing you are getting more than the true total return, which inherently accounts for both capital appreciation (or depreciation) and dividend payouts. The goal should always be to maximise the entire pie – the total return.

Our take: Always look at the total return of your investments. Don't be swayed by just the dividend yield. A higher total return, whether from capital gains or a combination of capital gains and dividends, is what truly builds long-term wealth.

Myth 2: Only dividend yields matter

The reality: A high dividend yield can be attractive, but it's not a standalone indicator of a healthy investment. Sometimes, a high yield is a “dividend trap” – simply the result of a falling stock price, making a struggling company look appealing. It might also signal unsustainable payouts, leaving little for future growth and risking dividend cuts.

This is precisely where active management of a fund manager becomes crucial. They conduct fundamental analysis to identify companies that are truly robust. This often means diversifying across different types of dividend payers: blending 'dividend cash cows' – established companies providing strong, consistent current payouts – with 'dividend growers' – companies with the financial health and growth prospects to consistently increase their dividends over time. 

This balanced approach, focusing on both the sustainability of current income and the potential for future dividend growth, inherently leads to a more diversified and resilient portfolio, looking beyond superficial yields to genuinely healthy businesses.

Our take: Endowus is not a stock picker, but we empower you with a curated selection of Best-in-Class funds, including those with actively managed dividend strategies. This allows you to benefit from our analysis that aims for robust total returns by looking beyond merely yield metrics and a process that can select companies with truly sustainable dividend policies.

Myth 3: You can rely solely on dividends for income

The reality: Unlike interest payments on a bond, which are contractual obligations, dividends are discretionary.

A company's board of directors can choose to cut, suspend, or even eliminate dividends, especially during challenging economic periods or if they need to retain cash for strategic investments.

We've seen this happen with various companies during market downturns. Relying solely on dividends for income without considering the underlying company's financial health and stability can introduce significant risk to your income stream.

Our take: Before considering dividend-focused investments, honestly assess your personal need for passive income. If generating a regular cash flow is your primary goal, dividend funds can be a consideration. 

However, avoid focusing too heavily on short-term cash payouts. If all your dividends are paid out, there’s nothing left to compound – a powerful engine for long-term wealth accumulation and creation. For most long-term investors, reinvesting dividends within a total return framework often leads to significantly greater wealth over time. 

Also, pay close attention to the share class selection. While a distribution share class can provide passive income, it's crucial to understand if the distributions are coming purely from the underlying investment's income or if they are distributing from the underlying invested capital. This distinction highlights why focusing on total return is paramount – it clarifies if your capital is being returned to you as income, or if genuine growth is occurring.

Myth 4: You just need a few blue-chip stocks for dividends

The reality: A common pitfall of focusing heavily on dividend-paying stocks is inadvertently concentrating your portfolio in a few specific sectors. Historically, high-dividend stocks have often been clustered in mature industries like financials, utilities, and certain consumer staples. 

Overweighting these sectors can leave your portfolio exposed to specific industry risks and reduce your overall diversification across different economic cycles and growth opportunities. 

True diversification involves spreading your investments across various asset classes, geographies, sectors, and investment styles, aligning with a total return philosophy.

Our take: We view dividend funds typically as a satellite allocation rather than a core component of your portfolio. They can be strategically used to express a view towards more mature markets and industries, which historically tend to pay out more dividends. 

For genuine diversification, ensure your portfolio extends beyond just dividend-heavy sectors. Your core portfolio, however, should remain broadly diversified across global asset classes, focusing on total return for foundational growth and to protect against downturns in any single area.

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