It's tough to see the forest for the trees...

It's tough to see the forest for the trees...


So, I read a very compelling post by a guy whose tagname is Chumpmenudo.  You have to like that name...He writes well, with substance.

He created some scenarios that show that a pure capital gains investing approach yields a larger portfolio value over time, given certain assumptions. He compared 10% capital gains with a combination of lower capital gains and dividend payments that add up to 10%, with dividend reinvestment.

On a one-to-one basis, he showed that higher capital gains outstrip the value of lower capital gains plus dividends. He made the argument that if you're not living off proceeds of your portfolio, total return is the only important metric, and you can always instantly switch to a dividend strategy when you need the income.

The problem here is that identifying a portfolio of guaranteed high growth companies that will perform at that level for decades is exceedingly difficult. Portfolio performance is about averages. You make bets, some of which are borne out and some fall flat.  One premise of dividend investment is that dividend history, along with an eye to the business metrics that support dividend payment, is a reliable indicator of companies that will continue to perform predictably over time. Volatility matters in a single stock, as well as a portfolio. You have to remember that famous WB quote; rule number one is "never lose money". Rule number two is "never forget rule number one".

I think it would be considerably difficult to identify a portfolio of 20-50 equities that all reliably produce 10% capital gains over time.  It may be similarly difficult to identify a portfolio of equities that on average produces 10% capital gains over time. That's why the entire mutual fund industry developed, after which the ETF industry developed, with both passive and active components. One is always given the choice of lower fee passive instruments that hope to track the market, or an index. The higher fees of actively managed instruments is supposed to yield market beating results, managed by professionals. The problem is, most of them don't.

Dividend growth investing is about building a portfolio one stock at a time. It rejects the "basket mentality" of index investing. It rejects the fees paid whether or not the portfolio performs. It rejects the concept that beating a benchmark is the indication of success. It recognizes that total return matters, as it recommends selling overvalued companies and repositioning into lower valued companies that pay a higher dividend and also have prospects for more rapid capital appreciation.

I haven't encountered a capital-gains only strategy that incorporates low volatility, markers of reliable performance over time,  total return "anchoring" dividend payments, the option to build a cash position to help with rebalancing (turn off the drip either globally or selectively). It may be out there, but it'll have to start making itself known by a prominent title that catches my eye, or I won't waste the time looking for it.

My portfolio yields about 4.5% dividends, all of which are reinvested. It needs to add another 5.5% capital gains to make a total of 10% total return as a portfolio yearly. I add another 6%  to it every year, maximizing my deferred income every year.  I find that to be comfortably achievable, without stretching too far.

What I need to do now is adopt a monitoring strategy that reliably sees the appropriate metrics at regular intervals for the whole portfolio.  That means finding a reliable spreadsheet, entering all the positions, and tracking dividend growth, earnings growth, payout ratio, growth in value, position growth, total portfolio performance.  I may have found one, and I'll be examining it carefully over the next several weeks.

I'll be watching that Chumpmenudo guy closely and see how he actually behaves, as opposed to how he blogs

New insights on DGI:

So much for go away in May, huh.... The pundits are saying we're at a peak and trouble is coming.
Certainly something is coming; election, lame duck session of congress, tax measures expiring, perhaps another collision with the national debt ceiling. The sky has been falling in Europe for literally months now...China's economy slowing to a veritable crawl at 7% per year; the sky must be falling somewhere, after all.

I'm a bit more comfortable with the idea of staying invested, since I'm trying harder to keep my eye on a different ball; not the portfolio value ball, but the rising dividend payment ball. Yields go up and down as the valuations go up and down. Hopefully, company revenues and profits continue to go up, on average, so dividend payments will also go up, and up at a higher rate than inflation. If that happens, my savings and DRIP plan will yield what I am aiming for; enough income in retirement to live off dividends, and not spend down capital positions.

I just read and memorized the single most important quote I have read in years: capital gains don't compound.  Remember that compounding interest is the 8th wonder of the world, the single most powerful financial force in the world.  How do you inject this force into market investments? You find investments where something is compounding!  There's no doubt that capital gains are a powerful engine for wealth accumulation. They generally make up about 2/3 of value appreciation in a position. However, if you add a multiplier that captures increasing amounts of that value appreciation, your overall gain skyrockets.  That's the secret sauce in Dividend Growth Investment over time. It's why the tortoise beats the hare. The hare has capital gains as it's only engine. The tortoise may not have legs like rockets, but dividend reinvestment puts more and more legs to work and each one piles on more capital gains force, and a bit more dividend capture force into the investment.

I continue to read about other investments; after all, my emerging market bond funds are still the strongest performers I own over the last 4-5 years. However, they have a similar component of capital appreciation as well as compounding as I re-invest the interest payments(dividends) into larger positions in the funds.  More secret sauce...

work beckons...