Do dividends enrich shareholders? Is investing only for the rich? True or false: five claims about investing

1. The larger the dividends, the richer the shareholder.

FALSE. A large dividend leads to an equal reduction in share price, resulting in no change to the shareholder’s total wealth after the dividend has been paid out. 

Let’s assume that an investor owns one share just before the dividend is paid out. If the share’s price was €10 before the payment of a €2 dividend, its post-dividend price is €8. In other words, the investor’s €10 ownership has now been converted into €8 in shares and €2 in cash. If the investor also has to pay tax on their dividend, the payment of the dividend actually made them less wealthy than they would have been without it. 

2. Investing is for rich people.

FALSE. You can start your investment portfolio with just €50 a month, for example. Suitable investment targets include low-cost investment funds or exchange traded funds (ETFs). When it comes to risk management, it makes more sense for a new investor to invest small sums in pre-diversified investment products than individual shares. 

3. On average, direct share investments are more profitable than fund investments.

TRUE AND FALSE. If the investor can assemble a well-diversified share portfolio while minimising their transaction costs, they may be able to achieve slightly higher returns on average than if they made a similar investment in a fund that charges fees for its management. However, the key elements are good diversification, minimising costs and avoiding investment mistakes that are rooted in various psychological phenomena. These mistakes include, for example, excessive trading and risk-taking stemming from an inflated sense of self-confidence; herd behaviour, such as following the latest investment crazes; and excessive investments in potentially profitable yet typically volatile targets, such as small biotechnology companies.

If an investor only has a few shares in their portfolio, they are likely to fall short of the stock market’s average return figure in the long run. Research has shown that as much as half of exchange-listed stocks have provided a negative total return during their listing period.   

4. In choosing an investment fund, expenses trump all other considerations.

TRUE AND FALSE. It’s also important to choose the right type of investment fund, as funds come in many shapes and sizes. Some funds are active, in which case their portfolio managers try to best the returns of their comparison groups, while others are passive. Some invest in shares, while others focus on bonds or other financial instruments, and many feature combinations of both of these categories. 

Studies have identified certain factors related to funds and portfolio managers that appear to be linked to better investment success. Above all, the most important factor seems to be the fees charged by a fund: the higher the fees, the lower the returns. One could say that when it comes to funds, the more you pay, the less you get. 

5. ‘Good companies’ represent the best investment targets.

FALSE. Many investors believe that it pays to invest in ‘good’ companies with visionary leadership, credible strategies, secure financial positions, high brand capital, well-known trademarks or other competitive advantages. This is a typical mistake, as the investor assumes that the factors that reflect the company’s success also reflect its value as an investment. If we can assume that a company’s investors all share this opinion, the company’s success should already be reflected in its valuation level – that is, in the share price. It is often the case that a company’s good reputation can even lead to an excessively high valuation. Numerous studies have shown that, on average, companies that meet the above criteria will offer lower equity returns to investors when compared to other stocks. 

Peter Nyberg is a professor at the Department of Finance in the School of Business. His research focuses on stock markets, the relationship between risk and return, and quantitative investment strategies.