Archive | Dividends

Why You Should Avoid DRIPs in Taxable Accounts

Last week’s post about calculating your adjusted cost base with ETFs drew some interesting comments. It’s clear that many DIY investors who use non-registered accounts were unaware of how much work is involved in accurately reporting capital gains.

Careful record-keeping is an unavoidable burden for taxable investors, but you don’t need to make it any more difficult that necessary. Yet as one reader pointed out (hat tip to Jas), some investors complicate their lives by using dividend reinvestment plans in non-registered accounts.

DRIPs allow you to receive ETF distributions—whether stock dividends, bond interest, or return of capital—in the form of new shares rather than cash. You can only receive whole shares, so if the ETF is trading at $20 and you’re eligible for $87 in distributions, you’ll receive four new shares plus $7 in cash. These plans are extremely popular with do-it-yourself investors, and they can be beneficial, since you pay no trading commissions on the new shares and your money starts compounding immediately rather than sitting idly in your account.

But although they are convenient in RRSPs and TFSAs, dividend reinvestment plans are usually not a good idea in taxable accounts.

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Calculating Your Adjusted Cost Base With ETFs

Being a DIY investor is easy when all your accounts are tax-deferred. As the April 30 tax deadline approaches, pretty much all you need to do is gather your RRSP contribution slips. But if you have nonregistered accounts, things are more complicated, even if you’re a Couch Potato who uses ETFs and index funds.

To begin with, you need to report any income you received during the year. This part is relatively easy: in February or March you should receive a T3 slip that includes a breakdown of the type of income you’ve received from your mutual funds or ETFs: dividends, reinvested distributions, and interest income. Just enter these amounts in the appropriate boxes on your tax return and your software—or your accountant—does the rest.

If you hold US-listed ETFs, you’ll receive a T5 slip from your brokerage: Box 15 contains the amount of foreign dividends you receive, and Box 16 will indicate the amount of foreign tax paid. Dividends from US and international companies are fully taxable as income, but you can recover the withholding tax by claiming the foreign tax credit on your return.

But there’s more to the story than simply reporting income.

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Ask the Spud: Do I Have Enough for a DRIP?

Q: I’m planning to use my 2013 TFSA room to purchase a bond ETF. How can I make sure I’m investing enough to benefit from a dividend reinvestment plan? – Phil B.

Dividend reinvestment plans (DRIPs) are a convenient way to make sure your money is compounding every month rather than sitting idly in your account. When you sign up for a DRIP, your distributions (whether dividends, interest or return of capital) are paid in new shares rather than in cash. Discount brokerages typically offer DRIPs for just about all Canadian ETFs, and you can arrange them with a simple phone call or email to the customer service desk.

The potential problem with DRIPs, however, is you can’t receive fractional shares: each distribution must be large enough to purchase one full ETF share, or it will just be paid in cash. Now that more ETFs are paying distributions monthly (as opposed to quarterly, which used to be the norm), each payout is small and you need a fairly significant holding before you’ll receive even a single new share with every distribution. But exactly how much do you need?

It’s not possible to calculate this amount precisely,

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Foreign Withholding Tax: Which Fund Goes Where?

My previous post on foreign withholding taxes included a lot of information for investors to puzzle over. But unless you’re an accountant, you probably don’t care too deeply about the finer details. Most investors just want to answer a simple question: which fund should I put in which account?

Recall from the earlier post that there are five broad categories of funds you can use for US and international equities:

A. Canadian mutual fund or ETF that holds US or international stocks directly.
B. US-listed ETF that holds US stocks.
C. US-listed ETF that holds international stocks.
D. Canadian ETF that holds a US-listed ETF of US stocks.
E. Canadian ETF that holds a US-listed ETF of international stocks.

To help you make the most tax-efficient choice for each type of account, see the tables below. I’ve specified which of the above fund categories are the most tax-efficient, and which ones carry the largest withholding tax burden. Then I’ve included some comparisons of specific funds. In each case, the pairs track the same index and use the same currency hedging strategy. Once again, a big thanks to Justin Bender at PWL Capital for helping me sort through these details.

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Under the Hood: First Asset Morningstar US Dividend Target 50 (UXM)

This post is part of a series called Under the Hood, where l take a detailed look at specific Canadian ETFs or index funds.

The fund: First Asset Morningstar US Dividend Target 50 Index ETF (UXM)

The index: The fund tracks the Morningstar US Dividend Target 50 Index, which was created specifically for this ETF. The methodology screens US companies based on five criteria: expected dividend yield, cash flow/debt ratio, five-year normal EPS growth, return on equity (latest quarter), and three-month EPS estimate revision. To ensure liquidity, all stocks in the index must also be among the top third in average daily trading volume. The top 50 stocks in this screen are then equally weighted in the portfolio (2% each) and rebalanced quarterly.

The cost: The fund’s management fee is 0.60%. Because the fund is less than a year old it has not published its full MER, but expect it to be at least 0.68% after factoring in the Ontario Harmonized Sales Tax.

The details: UXM is designed to give dividend-focused Canadians a one-stop solution for diversifying into the US market. The index is based on the US Income model portfolio that is part of Morningstar’s Computerized Portfolio Management Services (CPMS),

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Apple and the Dividend Puzzle

As loyal readers will know, I’ve been critical of the zeal with which some investors approach dividends. Based on countless blog posts, emails and conversations, I feel that many investors’ preference for dividends is often irrational. And that’s not simply my opinion—the dividend puzzle has been a popular topic in financial theory for decades.

There are some situations where dividends are clearly preferable to price appreciation. The most clear-cut is the tax advantage enjoyed by investors (especially those in a low tax bracket) who hold Canadian dividend stocks in a non-registered account. But there are other situations where investors should actively avoid dividends—and yet they flock to them anyway. The latest example of misplaced enthusiasm comes from Apple.

As everyone knows, Apple announced in March that it will pay a quarterly dividend starting later this year. Predictably, the news was met with widespread approval—the dividend was called “payback,” and a “reward.” As The Globe and Mail reported, “It will raise demand for the stock, since dividend-focused investors, mutual funds and exchange-traded funds will now put Apple on their radar screens.”

Therein lies the puzzle.

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Did Your ETF Just Get Riskier?

One of the problems with actively managed mutual funds is that you can never be sure that the risk level will remain constant. In an income fund with a mix of government bonds, high-yield corporate bonds and dividend-paying stocks, for example, the exposure to these asset classes can vary according to the manager’s whims. Well, it turns out that same is true of some ETFs.

The iShares Diversified Monthly Income Fund (XTR) uses several other iShares ETFs to offer a blend of “income-bearing asset classes, including, but not limited to, common equities, fixed income securities and real estate investment trusts.” The fund’s web page makes it clear that “BlackRock Canada will review, and may adjust, XTR’s strategic asset allocation from time to time, as market conditions change.” However, in practice, the fund’s asset mix has remained virtually unchanged since its launch in August 2010.

But not anymore. XTR recently made a big shift that has significantly changed its risk profile (hat tip to reader Alec P. for pointing this out). Here’s how the fund’s holdings have changed:

Holding
Feb 29
March 22

iShares S&P/TSX 60 (XIU)
15.0%

iShares DJ Canada Select Dividend (XDV)
14.6%
5.0%

iShares S&P/TSX Equity Income (XEI)

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When “Buy What You Know” Makes Sense

Last week, My Own Advisor wrote an interesting post about whether investors should buy companies they’re familiar with. He was responding to a recent article by Larry Swedroe, which argued that “Buy what you know” is a bad strategy. Swedroe himself even joined the spirited debate in the comments section.

As I read the post and the comments, it struck me that the two sides were arguing two very different points. In the interest of being a peacemaker, I’d like to frame this debate differently and find some common ground.

Why pick stocks?

Let’s start at the beginning by asking why investors pick individual stocks in the first place. Back in the days of Graham and Dodd, investors had little choice but to analyze and buy individual companies, since there was no way to “buy the market.” That hasn’t been true for a long time, of course. Today, buying the market is easier and less expensive than ever. With equal amounts of the Vanguard Total Stock Market ETF (VTI) and the Vanguard Total International Stock ETF (VXUS), for example,

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A New Dividend ETF With Secret Sauce?

Last June, a new ETF provider appeared in Canada with little fanfare. I didn’t write anything about the launch of XTF Capital at the time, because their first lineup of products was a series of covered call ETFs and a convertible bond ETF that have little or no relevance to Couch Potato investors. However, last week XTF launched the first three ETFs in a new family that will track indexes provided by Morningstar. One of these, the XTF Morningstar Canada Dividend Target 30 (DXM), may be of interest to passive investors who use a dividend-focused strategy. So it’s worth a closer look.

Of course, the Canadian dividend ETF space is already a little crowded, with the iShares Dow Jones Canada Select Dividend (XDV) and Claymore S&P/TSX Canadian Dividend ETF (CDZ) currently holding almost $1.7 billion between them. Broken down by sector, this new XTF fund is about 25% financials (that’s half as much as XDV, but about 4% more than CDZ) and almost 30% energy, which is a far greater share than either of its competitors. It also holds 13% in utilities and almost 20% in telecoms.

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