Steady dividends beat investment volatility

Last March I published an article regarding the hazards of volatility in a stock selection.  In that example I compared a 4% annual dividend payer experiencing no growth against a non-div stock that experienced value swings up and down.

This post revisits that exercise but in a slightly different way.  As before, I started with a 4% dividend payer providing no value growth against a non-dividend stock that is uniformly volatile with regard to value.  In other words, the value of the stock increases a specific amount in one year then decreases a specific amount the following year. That pattern was repeated through 20 years.

I was trying to get a sense of how big stock gains have to be to offset corresponding declines over time while resulting in an outcome close to the straight 4% growth path.  The table below, built in excel, shows the results.

Start	$  10,000.00	Annual Growth	$     10,000.00	Annual Growth
1	$  10,400.00	4%	$     12,000.00	20%
2	$  10,816.00	4%	$     10,800.00	-10%
3	$  11,248.64	4%	$     12,960.00	20%
4	$  11,698.59	4%	$     11,664.00	-10%
5	$  12,166.53	4%	$     13,996.80	20%
6	$  12,653.19	4%	$     12,597.12	-10%
7	$  13,159.32	4%	$     15,116.54	20%
8	$  13,685.69	4%	$     13,604.89	-10%
9	$  14,233.12	4%	$     16,325.87	20%
10	$  14,802.44	4%	$     14,693.28	-10%
11	$  15,394.54	4%	$     17,631.94	20%
12	$  16,010.32	4%	$     15,868.74	-10%
13	$  16,650.74	4%	$     19,042.49	20%
14	$  17,316.76	4%	$     17,138.24	-10%
15	$  18,009.44	4%	$     20,565.89	20%
16	$  18,729.81	4%	$     18,509.30	-10%
17	$  19,479.00	4%	$     22,211.16	20%
18	$  20,258.17	4%	$     19,990.05	-10%
19	$  21,068.49	4%	$     23,988.06	20%
20	$  21,911.23	4%	$     21,589.25	-10%
Advantage	1%

If a $10,000 portfolio achieves 20% growth in year one but declines 10% in year two and repeats that pattern through 20 years, the volatile portfolio lags the steadily compounding portfolio by 1%.  This example assumes no money was added or subtracted from the portfolio.

If the value gains  are moved to 21% each year while holding the 10% declines steady, the volatile portfolio outperforms.  However, if value gains fall below 20% while the 10% declines remain constant, the performance advantage offered by the constant growth portfolio widens considerably.

Things to consider given the example above:

• Gains have to be significantly greater than losses for a volatile portfolio to achieve parity with a constant growth option.
• Losses should be mitigated as much or as often as possible for a volatile portfolio to achieve parity with a constant growth model.

The effects of volatility perfectly illustrate the following investing wisdom:

"The key to success [in investing] lies in avoiding losers, not in searching for winners."  -- Howard S. Marks

"Avoiding serious loss is a precondition for sustaining a high compound rate of growth."  -- Roger Lowenstein

"Rule #1:  Never Lose Money;  Rule #2:  Never Forget Rule #1."  -- Warren Buffett

Dividend Farmers don’t mind following the lead of successful investors.  On long journeys it’s often better to go with an experienced guide than venturing alone.  With the start of a new year we should keep learning, let the dividends compound, and work on steady growth.

Here’s to a success Dividend Farming effort in 2020.  Happy New Year!

Thoughts presented are those of the author, who is not a financial professional. Perspectives are not investment advice, but offered for the purpose of discussion and information. For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.