Archive | Dividends

Debunking Dividend Myths: Part 3

This post is the third in a series exploring the myths and misunderstandings about dividend investing. The goal of the series is to argue that many investors following a dividend-focused strategy may be better off with broad-based index funds.

Dividend Myth #3: Dividend-paying stocks are a substitute for bonds in an income-oriented portfolio.

It’s awfully hard to get excited about fixed-income investments these days. During most periods in the past, bonds and GICs paid interest rates significantly higher than the average stock dividend. But not today: five-year GICs are now pulling down about 3%, while 10-year federal bonds are earning less than 3.5%. The dividend yield of the S&P/TSX Composite Index is about a point lower than that, but it’s easy enough to build a stock portfolio that pays 4% or more.

No wonder I frequently hear from investors who have ditched fixed-income investments altogether in favour of dividend-paying stocks. Indeed, some popular dividend gurus advocate throwing fixed income to the dogs altogether, no matter what market conditions happen to be. “I don’t understand why people switch to bonds in retirement,” writes Tom Connolly of the popular Dividend Growth website.

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Debunking Dividend Myths: Part 2

This post is the second in a series exploring the myths and misunderstandings about dividend investing. The goal of the series is to argue that many investors following a dividend-focused strategy may be better off with broad-based index funds.

Dividend Myth #2: Dividend investors are successful because they select excellent companies and buy them when they are attractively priced.

Every morning Larry takes a brisk walk with his beloved German shepherd and then enjoys a Dole banana and a cup of nonfat Yoplait. He eats organic lunches at The Angry Vegan, and three times a week he visits The House of Pain, where he lifts weights, swims or does a spinning class. Larry follows this routine for decades (he goes through a few German shepherds) and remains spry and active into old age. One day, Larry’s great-grandson asks him for the secret to keeping so healthy. “It’s all about making good choices,” the old man replies. “Start by choosing a breed of dog that is strong and long-lived. Then buy only recognized brand names for your breakfast foods. Finally, always patronize restaurants and fitness clubs that are well managed and highly profitable.”

When I hear dividend investors talk about their success,

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Debunking Dividend Myths: Part 1

This post is the first in a series exploring common myths and misunderstandings about dividend investing. The goal of the series is to argue that many investors following a dividend-focused strategy may be better off with broad-based index funds.

Dividend Myth #1: Companies that pay dividends are inherently better investments than those that don’t.

Many investors take it for granted that dividend-paying companies are superior to those that do not pay a yield. But this idea has been the subject of debate for decades, and many academics believe that it is irrational.

Let’s start with something everyone can agree on. Equity returns have two components: capital gains (price increases) and dividends. Add them together and you have the total return for a stock. Ignoring taxes and transactions costs, a stock that pays no dividend but increases in price by 6% provides precisely the same return as one whose share price rises 4% and pays a 2% dividend.

Dividends lead to a drop in share price

What many investors don’t grasp is the direct relationship between share prices and cash dividends. If a company’s stock is trading at $20 and it pays a $1 dividend,

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When Does a Dividend Strategy Make Sense?

My last couple of posts have dealt with stock picking and dividend-based indexes, and they’ve sparked some of spirited debate in the comments sections. Much of the feedback has come from dividend investors, and it’s prompted to me to finally write a series of posts that I’ve been researching for some time.

Dividend investing is perhaps more popular than it has ever been. There are two obvious reasons for its increased appeal. First, many people have lost faith in the growth prospects for equities and see dividend payouts as more reliable than share-price increases.  Second, the low rates on bonds and GICs have made dividend yields even more attractive to income investors. But if the emails and comments I’m receiving are any indication, many investors have flocked to dividend investing for the wrong reasons, without understanding the risk-reward trade-off.

When dividend investing may be best

Let me stress something before we go any further. I am not suggesting that building a portfolio of dividend stocks is a bad strategy. Many savvy investors have done so successfully for years, and it would be supremely arrogant for me or anyone else to tell them they’re wrong.

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The Tyranny of the Aristocrats

Last August, Rob Carrick of The Globe and Mail wrote a piece about Canadian dividend ETFs and he invited three bloggers — me, Canadian Capitalist and Million Dollar Journey — to offer our picks. My colleagues both chose the Claymore S&P/TSX Canadian Dividend ETF (CDZ), one of the more popular ETFs in Canada, with almost half a billion dollars in assets. I took a different view, suggesting that investors consider buying equal amounts of CDZ and the iShares Dow Jones Canada Select Dividend Index Fund (XDV).

My reason for that recommendation — explained in this August 2010 post — was that the ETFs track two very different indexes, and there was surprisingly little overlap in their holdings. Well, that’s even more true today. The S&P/TSX Canadian Dividend Aristocrats Index, the benchmark for CDZ, was reconstituted in December, and the changes were dramatic: the Claymore ETF now has zero exposure to banks and insurance companies. Its iShares competitor, meanwhile, is more than 51% financials: the Big Six banks alone make up almost 30% of XDV.

How to become an Aristocrat

To understand what’s going on here,

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Under the Hood: Claymore Global Monthly Advantaged Dividend ETF

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: Claymore Global Monthly Advantaged Dividend ETF (CYH)

The index: Zacks Global Multi-Asset Income Index, which was created specifically for Claymore. It combines the Zacks Multi-Asset Income Index (made up of U.S. securities) and the Zacks International Multi-Asset Income Index, which includes developed and emerging countries outside the U.S.

This is a “strategy index,” which means it is not designed to passively track the whole universe of dividend-paying stocks. Rather, the securities are hand-picked “using a proprietary model based on dividend growth, the capacity to increase the current dividend, liquidity, and dividend yield.” The methodology is not made public.

The most important thing to understand about the Zacks index is that it is not limited to common shares of dividend-paying companies. Almost half the index is made up of preferred stocks, American depositary receipts (ADRs), real estate investment trusts (REITs), master limited partnerships, and closed-end funds.

The cost: The fund’s MER is 0.67%,

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Choosing a Dividend ETF

Rob Carrick’s column in The Globe and Mail this Saturday looked at the three dividend ETFs listed on the TSX. Rob asked three bloggers to share their picks: Canadian Capitalist, Million Dollar Journey, and yours truly. I’d like to explain my choice in more detail.

Let’s begin with a review of the three ETFs in question:

Horizons AlphaPro Dividend (HAL) is an actively managed ETF that “invests primarily in equity securities of major North American companies with above average dividend yields.”

Claymore S&P/TSX Canadian Dividend (CDZ) tracks the S&P/TSX Canadian Dividend Aristocrats Index, which focuses on dividend growth. Companies in the index must have raised their dividends in each of the last five years.

iShares Dow Jones Canada Select Dividend (XDV) holds the 30 highest-yielding stocks, though it also screens candidates based on dividend growth and average payout ratio.

I don’t think active management will add value after costs, so that rules out HAL. This ETF currently holds about 10% in cash, reserves the right to hold preferred shares and bonds, and its commentary talks about waiting for the market to reach its targets before deploying that cash.

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