Larry Swedroe on the evils of dividend juicing.
Mutual funds can meet investors’ desire for large dividend payments in two ways. Either they can buy high-dividend-yield securities, or they can artificially increase their dividend yields by “buying the dividends” (or “juicing” them). The process involves purchasing stocks before the day on which the dividend will accrue to investors (known as the “ex-dividend day”), collecting the dividend and then selling the stock afterward.
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Not unexpectedly, the authors found that juicing is costly to investors through higher trading costs (commissions, bid/offer spreads and market impact costs). They found that funds with an excess dividend ratio above 1.38 have turnover 11% higher (with a t-stat of 4.2). Funds with an excess dividend ratio above 2 have turnover 17% higher (with a t-stat of 4.0). In addition, juicers incur increased taxes, ranging from 0.6% to 1.5% of fund assets per year. And this assumes that all dividends are qualified.
The implication is striking: “Investors who seek an income stream are better off creating it by selling fund shares than by investing in a fund that juices.”
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Finally, the authors noted their results are consistent with investors who psychologically distinguish between consuming income produced by their assets and consuming the capital value of their assets. This is simply a labeling error (or a framing problem), and thus leads to irrational behavior. Unscrupulous mutual funds, however, cater (or pander) to unsophisticated investors, charging higher fees and delivering lower returns with less tax efficiency.