One of dividend investing’s most attractive attributes is its simplicity: you buy a stock, you get paid. Because of that simplicity, dividend investors can enjoy an advantage that eludes those choosing more complex and sophisticated investments: low costs.
Paying for Nothing
The issue of investment costs is the subject of an excellent column by Elliot Blair Smith on Marketwatch.com. Smith writes: “Quite often investors end up paying for nothing, when…promised services aren’t performed; or overpay for average returns and underperformance. Some drags on earnings include management fees based on inflated asset values, valuation methodologies that change opportunistically midstream, and layers of unnecessary, or non-independent, experts that become conduits for…“back door” fees. Alternatively, when capable investment managers do beat the market, sometimes they allocate much of the benefit to themselves.”
Private equity deals and hedge fund investments are mainly what Smith is talking about, but fees in complex mutual funds and managed accounts at brokerage firms can also be quite high. The reason those costs are high — and rarely come down even when the fees are exposed or the firms charging the fees are fined or penalized — is because consumers of financial services rarely examine the cost of those services. It’s probably a quirk of human psychology, but consumers who will comparison shop for anything they buy (even expensive, luxury goods like BMWs and fur coats) rarely examine the costs of investments. Yes, the fees and costs are opaque but somehow in investment there’s a belief that you get what you pay for — which is rarely true.
Not So Smart
In one famous example, Harvard professor David Laibson asked MBA students, undergraduates and university staff to select an index mutual fund from a group of four real S&P 500 index funds. Despite choosing from identical funds, none of the subjects minimized fees, which was the only difference among the funds.
“In our main experimental group,” Laibson wrote, “staff, MBA students, and college students respectively paid 201, 112, and 122 basis points more in fees on average than they needed to. Staff and college students reported in debriefing surveys that fees played relatively little role in their portfolio decision.”
What’s so shocking here is that the only difference among those four index funds was fees, and that the subjects — arguably the best and brightest among the most financially savvy in the nation — ignored costs and focused on historical performance. Even that emphasis shows how nutty people are, because the reason the historical performance of the funds differed was because each fund began at a different date and measured performance over different time frames; the true annual performance of each fund tracked the performance of the S&P 500 index!
What Dividend Investors Know
Dividend investors generally sidestep the quirk in human behavior that leads us to avoid being rational when pricing financial services. If you maintain a discount/low-cost brokerage account through which you buy dividend stocks and rarely trade, you will not only have the best chances to earn a decent return on your money but also save a bundle by avoiding high-cost investments in which you can’t even tell what the costs are.
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