Dividend investing vs Index Investing (& Hybrid strategies)

Ahh, the age-old debate… dividend investing vs. index investing. Is one better than the other?

Well, like any good debate, there is much evidence that can support both sides of the argument.

For example, dividend investors will quickly point out that over the long term, dividend stocks return better than non-paying dividend stocks.

On the other hand, index investors will point out that dividends are irrelevant.

I’m not going to argue which one is better on this post, but you can probably figure out where we stand given we are hybrid investors.

When it comes to investing, it’s super easy to just take all the numbers, plug them into the different formulas, and analyze the results to the nth degree. There have been a lot of books on how to invest based on mathematical formulas or theories.

They are all good and all, but I would argue that investing in real life is very different than running mathematical analysis.

30% investment strategy vs 70% psychology

In my short +15 years of DIY investing career, I have come to realize that investing in real life is not just about investment strategy and analysis. Rather, I believe investing in real life is about 30% investment strategy/theory and 70% psychology.

Psychology plays an important role in deciding whether your investment is going to be a success or a failure. It is also the number one reason why people end up buying high and selling low even though they should be doing the complete opposite.

When your hard-earned money is melting away faster than ice cream on a sunny day, all you care about is preserving whatever money you have left, so you end up selling low on emotion. On the other hand, when stocks are going higher and higher and you’re seeing everyone and their dogs making money hand over fist (and paw ha!), you want to get in on the action as well, so you end up buying high on emotion.

I believe strongly this is where dividend investing shines and why dividends do matter. Because dividends do calm the nerves during volatile market conditions. Receiving steady dividends, regardless of how the stock price is doing, will allow investors to stay invested longer.

Take two stocks, A and B. Stock A doesn’t pay any dividends while Stock B pays a 3% dividend every quarter. All things being equal, if the price of both stocks goes down by 30%, which stock do you think gets sold more by investors?

Dividend stocks more likely to be held in bad times

I believe Stock A, because investors don’t see their money working hard for them. For Stock B, because of the steady 3% dividends, investors are more likely to hold on during bad times and wait for the stock price to recover.

Furthermore, if you have done really well with an investment online portfolio where you invest with a fake starting capital, I’m sorry, you probably won’t learn too many investment lessons from this experience. Why? Because most of these fake money portfolios only last a short period of time so investors end up betting on high risk high reward stocks. And since the money you’re using is fake money, who cares if you lose all of them?

Ask yourself, would you do the same with your hard-earned money?

So is dividend investing better than index investing? Well, I certainly can’t answer that question myself and whichever side you’re on, I’m sure we will definitely come to the conclusion that we will agree to disagree. What we probably can agree wholeheartedly is that dividend investing and index investing are a heck a lot better than hiding money under your mattress!

As I’ve heard many years ago – “when it comes to investing, your ego is not your amigo.” Psychology matters!

Finally, to be better investors, we really need to focus on learning more about the psychological side of investing. This is why I enjoyed reading The Bahavior Gap so much! If you haven’t read it before, please do yourself a favour and read it!

Hi there, I’m Bob from Vancouver, Canada. My wife & I started dividend investing in 2011 with the dream of living off dividends in our 40’s. Today our portfolio generates over $2,700 in dividends per month. This post originally appeared on Tawcan on Sept. 23, 2022 and is republished on the Hub with the permission of Bob Lai.