MENU

Beware of Funds That “Juice” the Dividends

It is a well-known fact that investors are attracted to high dividend yields. However, in reality, the dividend yield is not the biggest factor in overall returns. A study has shown that companies that give dividends usually do not perform better than similar companies that do not. And yet, investors are more attracted to the dividend paying stock.

Unfortunately, funds know this trend and instead of rationally choosing the stocks that will perform better, they might deliberately choose stocks that pay dividends but perform worse overall in a bid to attract investor dollars to their fund.

Dividend juicing

Dividend juicing is another method that funds employ to increase their yield. What this entails is buying stocks before the ex-dividend date and then selling the stock afterwards, accumulating the dividends.

This allows the funds to collect the dividends, despite not owning the shares for a long period.

How this affects returns?

Unsurprisingly, this strategy of investing is detrimental to shareholders’ returns in the long run.

Firstly, funds incur a much larger trading cost due to the short holding period of each position. The market will also react appropriately after the ex-dividend date, as the share price of the stock will drop, reflecting the reduced company assets after the dividend payout.

Secondly, funds in some countries will also incur much larger tax costs due to the dividends and the short holding period of the stock.

Overall, despite the seemingly larger dividend yield, investors will reap smaller returns as the net asset value of the fund decreases.

Who are the buyers?

Unfortunately, the main buyers of such funds are less sophisticated individual investors who are attracted to the higher yield. Individual investors are less likely to crunch the numbers and to realise the difference in return over the longer-term.

They may focus exceedingly on the amount of dividend paid out, causing them to make irrational decisions that can affect their investment returns.

The Foolish bottom line

Investing in funds can be extremely tricky for retail investors who may not focus on the right objectives. Funds use certain tricks to their advantage to exploit the less savvy investors. Potential investors should keep a lookout for such unscrupulous behaviours.

Meanwhile, for more (free!) investing insights, sign up here for your FREE subscription to The Motley Fool's investing newsletter, Take Stock Singapore. It will teach you how you can grow your wealth in the years ahead.

Like us on Facebook to keep up-to-date with our latest news and articles. The Motley Fool's purpose is to help the world invest, better.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.