Swedroe: Vanguard Debunks Dividend Myth

September 18, 2017

Vanguard’s conclusion that a total-return approach is superior to one that focuses on dividend strategies is interesting in light of the fact that they offer dividend strategy funds: the Vanguard Dividend Appreciation ETF (VIG) and its mutual fund counterpart, the Vanguard Dividend Appreciation Index Fund (VDADX), as well as the actively managed Vanguard Dividend Growth Fund (VDIGX).

Focus On Dividends Reduces Diversification Benefits

It’s important to understand that a preference for dividends has negative implications in terms of diversification, because about 60% of domestic stocks and about 40% of international stocks don’t pay dividends.

Thus, any screen to include only dividend stocks results in portfolios that are much less diversified than they would be if nondividend payers weren’t excluded in the portfolio design.

Less diversified portfolios are less efficient because they have a higher potential dispersion of returns without any compensation in the form of higher forward-looking return expectations (assuming the exposure to investment factors are the same).

Before concluding, there is one more important point to cover. As previously noted, both the high-dividend-yielding and the dividend growth strategies have exposure to the low-volatility factor, which has been “cursed by popularity” as low-volatility strategies experienced large inflows in the aftermath of the 2008-2009 financial crisis.

To see the impact of this heightened popularity, we’ll take a look at the valuation metrics of the two largest low-volatility ETFs, the iShares Edge MSCI Min Vol USA ETF (USMV), with $13.8 billion in AUM at the beginning of September 2017, and the PowerShares S&P 500 Low Volatility Portfolio (SPLV), with $7.0 billion in AUM.

We’ll then compare their value metrics to those of the iShares Russell 1000 ETF (IWB), which is a market-oriented fund, and the iShares Russell 1000 Value ETF (IWD). The table below is based on Morningstar data as of Sept. 7, 2017.



As you can see, valuations, whether based on price-to-earnings, price-to-book or price-to-cash flow, are higher for the low-volatility strategies than for the market and Russell 1000 Value strategies. This indicates the popularity of low-volatility strategies has caused their prices to rise and, therefore, exhibit lower forward-looking return expectations.


Both theory and historical evidence demonstrate there isn’t anything unique about dividends. They are just another source of profit, along with capital gains. Yet many investors treat these two sources of profit very differently, with negative consequences in terms of lower returns, greater risks and less diversified portfolios.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


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