It is also good to read Chris Dillow's comments, which are more refreshing than the conventional wisdom trotted out by so much of the 'sellside' part of the investment industry. When assessing one identifiable type of reader portfolio, the one being run for income, Chris's usual response is to say, in effect, why bother? Or, as he wrote in the clinic of 28 August 2015: "I do question your desire for dividend income. Is this really tax-efficient? Remember that you can in effect create your own dividends by selling some shares. Such sales might well be less taxable than income."
Absolutely true. Even so - and in response to a question that comes Bearbull's way from time to time - equity dividends and, by extension, income portfolios do have their uses since they can reach parts that selling bits of stock can't. This, too, is connected with human nature; in particular, something that's labelled the 'principal/agent conflict'.
Broadly, the world is divided into 'principals' - ie, the owners, who, as we shall see, are both literal and metaphorical - and 'agents', who are employed by the principals to look after their interests.
Within quoted companies, the principal/agent conflict is literal, well-documented and difficult to solve. The principals - the shareholders - own the company but, mostly, don't run it. For that purpose they hire agents - the managers. Problems arise because the managers say one thing and do another. They say they're running the company chiefly for the benefit of the shareholders; actually, however, they prioritise their own interests. This constant danger - at least from the owners' perspective - is especially real within quoted companies because there are likely to be thousands of shareholders, few of whom have the expertise or the incentive to tackle recalcitrant managers.
One way in which this dilemma is controlled is via the panoply of corporate governance controls that burden quoted companies. Arguably a more effective way is to make a company's managers pay out much more retained profits as dividends. The background logic is that managers will try to keep more profit than they need because cash gives them a comfort blanket; the more that managers have cash, the more they are independent of shareholders to pursue their own self-interest. Put this proposition the other way around - starve managers of cash and shareholders keep them lean, hungry and honest. And the best way to do that is make them pay out most net profit as dividends. It's the principle on which the private equity industry is run.
Meanwhile, the agent/principal conflict is metaphorical when it's a contest within ourselves. There is a principal, who acts responsibly with our best long-term interests in mind, and there is an agent, who is a slave to instant gratification. Bearbull knows the dilemma only too well. The principal urges me to do the washing up followed by 30 minutes on the exercise bike, while the agent says: "No sweat. Have another Jammie Dodger," as I sprawl on the sofa watching Cradle to Grave.
Something similar goes on with investors and dividends. Theory says you can create all the dividend income you need by tearing off a few shares and selling them; and that's sensible because it will be tax-efficient if you are using a capital gains tax allowance. In practice, though, the agent gets the upper hand. So you tear off too many shares because that gives you an extra bit of spending power. Before you know it, you're sacrificing the future value of your portfolio for some frivolous spending today.
However, dividends provide an external self control. The irresponsible agent is excluded from the decision-making because the company bosses decide how much dividend income you receive and that's an end to the matter. Simple and effective.
Besides, dividends solve another psychological problem that dogs investors when they create their own income - the difficulty of distinguishing between form and substance. Form does not matter, it's just about appearances; substance does - it's real. Often, however, we can't see beyond the form.
The reality - the substance - of creating income by selling a few shares is the same as the reality of getting income via dividends, as much finance theory will attest. But it does not feel like that, especially when share prices are falling. Then investors find it tough to create income via share sales because the impression - the form - is that they are losing twice: once when prices drop and once when the size of the holding is trimmed.
Away from human nature and to do with the nature of shares, income funds, which are just an aggregation of dividend-paying stocks, have a helpful characteristic - they tend to perform better than growth funds. The reasons, which are to do with supposedly ex-growth stocks being serially underrated, are well documented. Despite that, the characteristic persists. Not always, but more often than not. As I said earlier, dividends have their uses.
