By Dimensional Fund Advisors
Inflation in the U.S. has surged to the highest level in nearly 40 years, reaching 7.9% in February 2022.[1, 2] This, coupled with the U.S. Federal Reserve’s decision to raise interest rates, has alarmed many investors.[3] Some are turning to dividend-paying stocks, hoping to receive more income protection and higher returns.[4] Will it work?
Before diving into the performance of dividend-paying stocks, it’s important to note that the percentage of firms paying dividends has declined globally.[5] 68% of U.S. companies were paying dividends in 1927, while only 38% of firms paid in 2021. By focusing only on dividend-paying stocks, we will be sacrificing diversification. In addition, a dividend-focused strategy does not necessarily provide stable income. In fact, changes in dividend policy are common, especially during times of higher uncertainty. For example, many dividend payers cut their dividends during the pandemic—in the first three quarters of 2020, dividends from each dollar invested in U.S. markets decreased by 22% compared to the same period in 2019.[6]
But do dividends help combat high inflation? To answer this question, we study the performance of Fama/French U.S. portfolios formed on dividend yield from 1928 to 2021.[7] At the end of each June, all U.S. companies are divided into two groups, payers and nonpayers, based on whether they paid a dividend during the previous 12 months. Then, within the payers, high payers are defined as the 30% of firms with the highest dividend yields, and the low payers are the bottom 30%. As of December 2021, the weighted average dividend yield is 1.8%, 0.7%, and 3.7% for payers, low payers, and high payers, respectively.
Exhibit 1 shows that all four dividend portfolios had positive nominal and real average returns in high-inflation years, when inflation was on average 5.5% per year.[8, 9] So outpacing high inflation over the long term is not a unique advantage of dividend-paying stocks. In addition, the return differences between payers vs. nonpayers and high payers vs. low payers are not reliably different from zero. Therefore, we don’t see strong evidence that dividend-paying stocks deliver superior inflation-adjusted performance during high inflation periods.
What about rising interest rates? We first look at the average monthly returns for different dividend portfolios in months with rising 3-month Treasury yields. Exhibit 2 shows that dividend payers, nonpayers, high payers, and lower payers had similar average monthly returns from March 1934 to December 2021. The conclusions are similar using the effective federal funds rate and 10-Year Treasury yields.[10] Piling into dividend stocks would not have led to superior returns in months with rising interest rates.
What should investors do? It is natural to be concerned about the potential impact of high inflation and rising interest rates on portfolios. However, we believe our analysis shows there is no reason to expect dividend-paying stocks or high dividend payers to offer more protection and higher returns during these periods. Market prices reflect the aggregate expectations of all market participants, including expectations about inflation and interest rates. Staying disciplined and broadly diversified, instead of chasing dividend stocks, may put investors in a better position to achieve their investment goals.
Article source: “Should You Chase Dividend Stocks to Combat Inflation and Rate Hikes?” by Mia Huang, mydimensional.com, 5 April 2022.
FOOTNOTES
1. “Consumer Price Index - February 2022," Bureau of Labor Statistics, US Department of Labor, March 10, 2022.
2. US inflation is measured as the annual rate of change in the Consumer Price Index for All Urban Consumers (CPI-U, not seasonally adjusted) from the Bureau of Labor Statistics.
3. Nick Timiraos, “Fed Raises Interest Rates for First Time Since 2018,” Wall Street Journal, March 17, 2022.
4. Hardika Singh and Michael Wursthorn, “Investors Gobble Up Dividend Stocks During Market Turbulence,” Wall Street Journal, February 8, 2022.
5. Stanley Black, “Global Dividend-Paying Stocks: A Recent History” (white paper, Dimensional Fund Advisors, March 2013).
6. “Dividends in the Time of COVID-19,” Insights (blog), Dimensional Fund Advisors, November 30, 2020.
7. See the Index Description for more information regarding Fama/French Portfolios formed on Dividend Yield.
8. High-inflation years are defined as having inflation greater than the full sample median, 2.68%, from 1928 to 2021.
9. Real returns are calculated using the following method: [(1 + nominal annual return) / (1 + inflation rate)] – 1.
10. “Federal Funds Effective Rate (FEDFUNDS),” Federal Reserve Bank of St. Louis (Percent, Monthly, Not Seasonally Adjusted).
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.