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I’m a first time poster and long time reader (including WSJ Getting Going) and saw an article today with behavioral finance observations. It may be of interest to some.
The names of equity-income funds imply that they are aimed at investors who desire to withdraw their higher dividends as cash flow for spending. On the other hand, equity funds are aimed at investors who seek to reinvest their lower dividends for capital appreciation. However, more than 74% of equity-income investors reinvest their dividends—a reinvestment rate similar to that of investors in equity funds. Why do investors who reinvest their dividends choose equity-income funds? This is what is called “the dividend reinvestment puzzle.”
Behavioral Finance
In their seminal 1984 paper, “Explaining Investor Preference for Cash Dividends,” Hersh Shefrin and Meir Statman offered a solution to the dividend puzzle—framing, mental accounting, and self-control. “Investors frame dividends into an income mental account, along with wages, whereas they frame capital into a capital mental account, along with retirement savings. Investors who withdraw money from their portfolios for spending, such as in retirement, use the self-control rule of ‘spend income but don’t dip into capital’ to prevent excessive spending. Investors who perceive selling shares to create homemade dividends as dips into capital prefer company-paid dividends over homemade dividends. Indeed, evidence indicates that investors place dividends in the income mental account ready for spending, whereas they are reluctant to dip into the capital mental account by selling shares.”
The full article is at The Dividend Reinvestment Puzzle: What It Means For Investors (fa-mag.com)
I have never seen the point of dividend reinvestment plans. I let dividends accumulate for a while, and then buy whatever stock seems to be the most promising. Usually, the bulk of dividends come from companies that are mature companies in a mature market, and you want to move capital into companies with more upside potential.
Well there is certainly healthy “debate” here with those who insist income is the only thing that matters and any other way of thinking about resources is not the same. Of course they too have their own logical flaws such as insisting maximising income is vital so it can be reinvested.
I recently commented that it seems absurd to me that people value dividends so highly when cum div and ex div values show you that it is just taken from your capital.
Welcome, and thanks for the link. Interesting read. I wonder if a more granular analysis of the figures would show differentiation between young and old investors regarding dividend withdrawal, and were tax implications for dividends considered? Perhaps that would partially drive the figures and explain part of the “puzzle.”