Downside Protection and Upside Potential :: Some investors choose to invest in high-dividend stocks as downside protection. Whenever income represents a large element of the expected total return, the time to receive back an initial investment is shorter than waiting for capital growth. This means the investor is less dependent on long-term assumptions about capital growth. This is a good thing: The longer the time horizon, the lower the probability of a correct forecast. Income investing effectively uses a time discount that places greater value on near-term returns. Other investors, by contrast, may be interested in dividend investing because they also want exposure to the upside of stock price appreciation. Special Factor: Trading Costs Trading costs for most securities are small, but they can add up over time. In a period of low or modest returns, transaction costs take a proportionately bigger chunk out of the returns. In that case, investors may prefer to hold assets longer. They will choose assets for their yield rather than hoping for an expected capital gain that would require a sale transaction to realise. The average holding period for equities declined on most stock exchanges over the last decades, although it has increased slightly since the financial crisis. For example, investors held NYSE stocks for an average of two years in 1991 but only for five months in 2008. The average holding period increased slightly to eight months in 2010. See chart above right. Source: World Federation of Exchanges. Note: The average holding period is the average total market value divided by the total value of trading in each year. London Stock Exchange data are consolidated with London SE Group from 2009 after the merger with Borsa Italiana. The trend toward shorter holding periods reflects lower transaction costs. This was spurred by innovations in information technology and increased competition thanks to deregulation. Bid-offer prices on the NYSE are now in pennies while spreads on major currency pairs are 1 to 4 basis points—a far cry from the situation two decades ago. Shorter holding periods also reflect the emergence of investment trends that generate more trading, such as exchange-traded funds and certain hedge fund strategies. As a result, will investors just merrily trade along and not worry about the balance between capital and income as sources of return? Not necessarily. In a prolonged period of low yields, avoidance of even very cheap transaction costs can become an important consideration. Another incentive to hold stocks longer could result from policy moves to discourage short-term trading. A prime example is the possible introduction of so-called “Tobin taxes,” named after Nobel Laureate James Tobin, who suggested a currency transaction tax in the 1970s. A doubling of the Swedish financial transaction tax in 1986 resulted in a 60% decline in turnover of the 11 most actively traded stocks on the Stockholm exchange (Steven Umlauf, 1993, “Transaction Taxes and the Behaviour of the Swedish Stock Market”).
Posted on: Sat, 20 Jul 2013 22:40:02 +0000
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