Investing is a very strange activity. While it should be totally based on rationale, it often produces emotions such as anxiety, greed, paranoia and anger. On better days it produces joy, pride and… sometimes… love… Yup, you can fall in love with a stock.
I think it’s even worse with dividend stocks!
Falling in love with a stock requires time and good results (read profits!). Since dividend investing is based on a long term model and aims for constant income; you get the perfect ingredients to fall in love!
The problem comes from the following question: Why Would You Sell Anyway?
If you had picked the right stock a few years ago, you are probably making a decent paper capital gain while earning nice dividend payments. Therefore, what would be the reason for you to sell? This is when it starts to smell like love in your portfolio ;-).
After a while, an investor may start to look only at the positive side of a stock and bringing back the past 2,3,4 years of good income. He tends to forget about average results thinking that the company will bounce back as it always had in the past. Plus, the share is giving a fat 5% in dividend yield. This is why you may think that you can handle the stock fluctuation while cashing strong dividends.
If the company keeps paying its dividend, is it that bad to fall in love with a stock?
I think this is where the problem is. I had once met a client who was holding on to Pengrowth Energy Trust (TSE:PGF.UN):
Back in 2006 when the income trust went public it was giving a monthly distribution of $0.25 per month per share (which is $3/year, so around 15% while the units were trading at $20 or so).
My client felt in love with this company as it was paying a high dividend yield and it was part of the flavor of the month in Canada; oil income trusts. Those were companies mainly based in Alberta exploring oil sand. The Canadian government offered them the option to convert their company into income trusts with huge tax advantages. So the dream went on until 2008:
Since then, the distribution started to fall and the shares followed the ride to hell. The problem when you fall in love is that you don’t look at the dividend payout ratio which was ridiculous in the case of Pengrowth but you look at the oil price coming back and you think that you are good for another ride with 15% dividend yield.
The worst is when you fall in love with a good stock
The Pengrowth story is an example of a bad investment choice turned into a love story since the fundamentals were never there concerning this company. However, the story of good investment choices turning into a bad romance is hard to predict.
I am currently falling in love with my company’s stock. It’s a Canadian banks and it pays a really good dividend yield. As part of my employee benefits, I can buy shares each month (8% of my base income).
I used to cash out my stocks once a year to pay off municipal taxes or other extra expenses. But this year, I am delaying my transaction as the stock keeps going up and the dividend yield is really good. On top of that, they have a great dividend payout ratio and they are even expected to be among the first Banks to increase their dividend yield in 2011 as predicted by financial analysts.
Here’s my dilemma;
I am holding a good dividend paying stock and I pay a lower interest rate on my line of credit than my dividend yield. Therefore it is very tempting to keep the stock and use my line of credit to pay off my expenses in the meantime…
I am not going to disclose my employer’s name but you can easily look at any Canadian banks to understand that they all show a great dividend investing opportunity.
So would you keep your investment or cash them out before you fall in love with your stock?
Hi Mike,
I agree that selling the stock to pay expenses seems silly when you have a line of credit with a lower interest rate than the dividend. If you don’t mind a bit of paperwork and the stocks are in a taxable account, I would sell the stock for the expenses and then immediately borrow the same amount of money from the LoC to re-buy the stock.
This would make the interest on the LoC tax-deductible (the amount that covered the stock investment), you get to keep the stock and dividends, and you’re paying your expenses in a tax efficient manner. You can then either pay down the LoC going forward or just pay the interest charges and keep the tax-deductibility (depending on how it’s set up of course, credit implications, etc.).
Looking forward to future posts,
Active Dividend Investor
@ ADI,
I agree with you, I have previously did it with my other investments. However, I am in a position where I don’t know if I will be able to keep my stocks for a long time. I might have to cash them by the end of the yar. I will atually apply this strategy if I can “survive” until the end of the year (receving my year end bonus on January 😉 ).
The first suggestion is a good one. However sometimes it just feels so good to pay off your debts too. In my situation right now I would cash out the stock if you are in the black with it and pay off/reduce my debts. The longer I carry my debt the more distaste I have for it.
I don’t think it’s a black and white situation. Mathematically speaking, the answer is always obvious but than you add in the human factor and plans can go sideways … I think it makes sense when you have a short term focus and you control the debt but I would not do it for the long term without a low ratio of loans.
I can easily find dividend investments that pay nearly 8% dividends. Many banks currently pay 3% to 5% but the prime rate is on the up so it’s just a matter of time before your offset shrinks. When comes time to sell, will you be expecting a price that isn’t met?
I noticed you move around following the low LOC promotion of 0% to 1% for the short terms and it would seem to work mathematically but what’s the gain? How much is the process really saving you? Then you have the tax factor if it’s not in a tax free account …
It’s not always a simple pure mathematical comparison … I sold my ESPP 3 weeks ago and if I had waited 3 days, I would have made an extra 1$ per share. However, the stock is so variable along with the economy that it could have gone down and then I have to wait …
You have a responsibility to yourself to put the protection of your portfolio above the possibility of gains. The protection of diversification and proper allocation cannot be understated, and you know it. You already know that you can’t be doing this. If the position gets too large, you need to trim it regardless of how rosy the future looks.
Intelligent investing means controlling your emotions.