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The Powerful Benefit of Not Blowing Up
The real reason why dividend growth investing works so well
I can think of few debates more useless than the dividend vs. total return one.
My favorite part is how each side thinks they’re dunking on the other, repeating like five points over and over again. But Nelson, did you know a buyback is functionally the same as a dividend???? Or that dividends aren’t tax efficient???? Or that dividends can be cut????
The other side isn’t immune to this either. They point out that buybacks aren’t the solution to all our problems, since management teams often undertake them when share prices are high. Or that for small investors with the majority of their net worth in an RRSP or TFSA that dividends are actually quite tax efficient. Or that creating your own dividend and selling when shares are down 30% might be a poor idea.
These arguments have been debated a million times before — including by a young Nelson, back in like 2012, a period I regret simply because of how useless that time was spent — and, to be blunt about it, you’re not bringing any new info to the table with your blog post or Twitter thread. That includes you too, academics. Nobody’s mind is changing on either side.
The fact is both methods work. Dividend growth investing has beaten the overall market consistently for decades now. Index investing does well too. A buy and hold approach for both methods absolutely crushes the performance of the average investor, who does dumb things like dabble in crypto.
So if both of these methods can work pretty well over a lifetime, let’s spend less time on what makes them different and more time on what I think is the powerful similarity between the two.
That commonality? It’s pretty hard to blow up both portfolios. Which is exactly the reason why they do so well.
The value of defense
For he that fights and runs away, may live to fight another day, but he, who is in battle slain, can never rise and fight again — Oliver Goldsmith
Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1 — Warren Buffett
Although it took me an embarrassingly long time to learn many of Buffett’s simple rules, one I’m especially ashamed about was my cavalier attitude towards loss.
Back in my deep value days I’d gladly put small chunks of my portfolio into what I called coin flip stocks. These names would work out, I thought, because it was like a coin flip on steroids. Heads I’d lose everything but tails would be a 3x-5x windfall.
I had enough winners to at least somewhat offset the losers. For every Danier Leather (went to zero) or Penn West (basically went to zero) I had stocks like Intertape Polymer (went up 3x) and Cloud Peak Energy (went up 4x). It worked just well enough to fool me into continuing. You also had to keep a close eye on every stock in such a portfolio and stomach a lot of volatility.
The problem with such a portfolio is pretty obvious in hindsight. The strategy was based on coin flip odds. In reality, the odds of each flip was far less than 50%. This put me in a bad spot during bear markets as iffy companies went from barely viable to flat-lining.
Compare that to my portfolio of boring dividend payers. It’s a strategy that performs well during bear markets, as evidenced by my performance in 2022:
Dividend payers, especially the boring boomer stocks I’ve stuffed into my portfolio, are mature businesses that have survived about 19 recessions already. They’re the defensive names other investors flock to when things get dicey.
Am I sacrificing some upside for this protection? For sure. I fully expect to underperform once the market recovers and all the tech stocks zoom again. I’m quite okay with this trade-off.
The beauty of singles
The real beauty of dividend investing is it’s really hard to blow up a portfolio stuffing it full of companies like Canada’s banks, our largest fast food companies, or consumer staples like Rogers Sugar. These are real companies that millions of people use every day. They might get a little stretched valuation wise, but never to the point where they’ll implode 90% in a bear market.
Everyone points at Coca-Cola back in 2000, when the company traded at 40x earnings. Yeah, it was expensive. But nobody blew up buying Coca-Cola at the top. Especially if it was part of a diverse portfolio filled with other similarly boring names.
Ben Trosky, a former bond fund manager from PIMCO, had a name for this phenomenon I absolutely love. He called it “strategic mediocrity” and it’s one of the more powerful fund management principles you can apply to your portfolio.
CHILDS: In the '90s, Ben Trosky was a money manager, and the game he thought he could win was buying and selling junk bonds. The way to win was to beat a benchmark, to stay above this line that is always going up and down… Trosky knows not to care much about the short term. Short time periods of a track record are meaningless. Trosky wants to be the best over the long haul, to be in the top 10%, the top decile, at the end of 10 years. He thinks he can because he came up with a plan.
TROSKY: When I did simulations, it became very, very clear that if you consistently stay in the top third but never end up No. 1, 2 or 3, that over time you would end up in the top decile of the competitive universe.
CHILDS: In this competitive universe, Trosky never wanted to be No. 1 in a given year's rankings because, in his scenarios, basically no one stayed on top because anyone in the top slot in a given year almost certainly got there by doing something reckless. They have to have taken too much risk, and they just lucked out. If they hadn't lucked out, they would have broken the most foundational rule of investing, which is to not lose money. To Trosky, it's better to take a lot of little swings all the time, measuring the risk against the potential reward, being picky, being strategic.
TROSKY: The idea of strategic mediocrity was my tongue-in-cheek title or name to put on the idea.
What a beautifully simple idea. Hitting consistent singles for twenty years won’t get any books written about you, but combine it with a reasonable savings rate and you’ll get rich.
And yet, despite this, Twitter is filled with investors who consistently take what I view to be massive amounts of risk. People go all-in on one stock, researching it to the point where they think it’s impossible to miss. Or they run massively concentrated portfolios with just a handful of names. Or maybe they do a lot of trading and just happen to only post the profitable ones.
That stuff used to bug me, until I realized these folks have very different goals than I do. These guys (they’re men, 99% of the time) are looking to either get rich in a hurry or make a name for themselves. Many either manage hedge funds or pine for the day they can start their own fund. Or they’re tired of working in some back office for Scotiabank and think a viable path out of there is to create a lot of attention on Twitter.
Those are all worthy goals, and I’m convinced working in a back office at Scotiabank is a special kind of hell. I’d try to get out of there, too. The issue is when folks start to follow these guys because they appear to be the smartest guys in the room.
Then there’s Nelson, who knows you only need to get rich once. I started work at 14 and never really took any time off until I hit 39. That’s 25 years I put into work. The last thing I want to do is fuck it all up by taking excessive risk. Which is why I aim for strategic mediocrity.
The bottom line
I firmly believe the main reason dividend growth investing works is it guards against investors blowing themselves up. Index investing works in the exact same way.
It’s a powerful concept that will go virtually ignored. Why is that? I think Mssrs Buffett and Bezos can give us our answer:
When asked what was the most important lesson he learned from Warren Buffett, Amazon founder Jeff Bezos recalled a conversation the two once had. “You’re the second richest guy in the world. Your investment thesis is so simple. Why doesn’t everyone just copy you.”
”Because,” Buffett replied “nobody wants to get rich slow.”