The standard dividend investing plan: Choose some solid companies with stocks that pay increasing dividends. Relying on dividends instead of capital gains avoids much of the guesswork and fear that plagues your average investor. Or so it seems.
It’s a Trap?
One major problem is humans’ tendency towards recency bias.
What is “Recency Bias”?
“The Party Effect or Recency Bias is where stock market participants evaluate their portfolio performance based on recent results or on their perspective of recent results and make incorrect conclusions that ultimately lead to incorrect decisions about how the stock market behaves.” (As reported by Wikinvest.com, no longer in operation.)
London, issued 1676.
A Short Jaunt into History
In 1900, the most predominant industry in the U.S. was railroads. Over 60% of the U.S. stock market capitalization in 1900 was for railroads. By 2000, that figure was less than 1%.
The second largest industry group in 1900 was iron, coal, and steel manufacturing. which consisted of more than 6% of U.S. market capitalization. By 2000, it too was less than 1%. Data courtesy Investopedia.
And so on
In the early twentieth century, automobile manufacturers were considered in the forefront of innovation. There were over 1,800 automobile manufacturers in the U.S. between 1894 and 1930 (cited here). Very few survived.
What this means
A dividend investor in 1900 would likely have chosen many stocks from industries which declined substantially over the coming decades. That is the trap a current investor would be better to avoid.
What About Today?
Today, within our lifetimes, we have seen industries and companies wax and wane. At one time IBM dominated computers. Later, Microsoft seemed to be the be all and end all of software. Many other companies come to mind. Game and computer hardware companies come and go, and technological innovation leapfrogs our imagination.
Do Any Survive?
I was as surprised as any to find a company that was founded in 1816, and has been paying uninterrupted dividends since it was founded. I cannot vouch for the suitability of investing in York Water Company (NASDAQ: YORW), but it currently pays a dividend of about 2%.
The Long Haul Is Long
Picking companies for the long haul is problematic. Picking dividend paying companies you expect to be around and thrive over decades can only be described as close to guesswork.
Looking Back
One approach is to pick those companies that have been around a long time and have paid increasing dividends for a long time. A popular list is of companies who have increased dividends for more than 25 years is known as Dividend Champions and is available here . This list was maintained by the late David Fish, and now other have picked up the task, for example, here and here. A simple Google search will find lists of other criteria and opportunities.
Looking Forward
As they say on Wall Street, “Past performance is no guarantee of future results.” So, how does one keep pace with change while at the same time sticking to the long-term dividend growth mindset?
A Way Out
One way is to be sure to diversify. Diversification does not mean only pick more than one company, but it means also pick companies in different industry sectors. This way, if one sector declines overall, you still have other sectors which could possibly increase.
As mentioned in a previous post, my dividend investments are in over thirty companies. If one company goes bust, it is less that one-thirtieth of the portfolio. At the same time, I have over thirty chances to continue to do well.
Pick Well
A factor I include in my investing is to think about industries where rapid technological innovation is common. These are probably the higher risk industries and companies. Avoiding these kinds of companies is often difficult because technological innovation is everywhere. But I do avoid companies with the hottest new games, that have the hottest new technical products, etc. Sure, I may miss some home runs. But I will take that risk.
Keep an Open Mind
Another way is to periodically find new companies to invest in. Dividend investing is not a “set and forget” activity, but can seem to be close to it. It certainly does not need as much attention as investing based on stock price (capital gains-type investing).
Funds
Of course, one way to avoid making decisions about individual stocks is to invest via mutual funds or ETFs. Doing so simply “out-sources” decision making to the index being followed or to the managers running the funds. Using funds or ETFs allows others to determine what to invest in. So the investor pays a fee for this privilege. In this mode however, one also gets companies one would not necessarily be interested in owning.
What do you think? See Comment page how to respond.
The post How to Avoid Being Trapped in Declining Industries when Dividend Investing appeared first in Smile If You Dare.