Your Complete Guide to Index Investing with Dan Bortolotti

Debunking Dividend Myths: Part 2

2018-06-17T20:38:42+00:00January 20th, 2011|Categories: Behavioral Finance, Indexing Basics|Tags: |34 Comments

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, I think of Larry. Because like my fictional fitness buff, these investors often achieve their goals without appreciating why. They save regularly and put their money to work in the equity markets, which have delivered better long-term returns than any other investment. They avoid high-fee mutual funds, keep their trading costs low, and carefully manage their accounts to minimize taxes. They hold their stocks for the long run and show strict discipline by not panicking when markets tumble. These factors probably determine 95% of their fate. Yet when dividend investors reflect on their wealth, they’re inclined to say, “I owe it all to my ability to choose excellent companies with good yield, and to buying them when they were attractively priced.”

The real reason dividend investors succeed

The most important factors affecting investment success are boring. When was the last time you bragged to a friend about how few trades you made last year? Or regaled your family with stories of your preauthorized RRSP contribution? Try as I might, I just can’t seem to get my hockey buddies interested in asset-class correlation.

By contrast, the hunt for dividends is exciting. People genuinely enjoy analyzing businesses, building their stock portfolios one company at a time, feeling smart when their picks do well, monitoring the markets for buying opportunities and, perhaps most of all, getting those cheques in the mail. This is clear from the zeal of dividend investors, which isn’t matched by people using any other strategy. There are no blogs called “Think Bond Ladders” or “The Capital Gains Ninja.”

There’s nothing wrong with this — indeed, people who enjoy investing are more likely to be successful than those who find it a chore. Anyone who tells a dividend disciple that they should switch strategies has failed to understand that investing isn’t only about earning the highest possible return. As Meir Statman has argued, investing has genuine expressive and emotional benefits.

However, because many dividend investors devote so much time and enthusiasm to identifying great companies at good prices, they mistakenly believe that this is the essence of the strategy. On the contrary, I think that dividend investors achieve their financial goals because they do everything else right. Their wealth comes despite stock picking and market timing, not because of it.

Beating the market is still a loser’s game

Dividend investing is a successful and enjoyable strategy. The problem is that it’s often extolled as a way to beat the market. This is the dangerous part of the myth, and a claim that should be challenged.

The fact is, dividend investing is simply a form of active management. I’m not going to rehash the whole active-versus-passive debate here — many books have been devoted to the topic, and the matter has been settled by academics. Suffice it to say that likelihood of any investor beating the market over a lifetime is extremely low. It’s probably higher for dividend investors than it is for mutual fund managers, who have much greater costs to overcome, but it’s still a long shot.

There is no shortage of data showing that dividend-paying stocks outperformed the overall market during many periods in the past. The problem isn’t that these data are wrong, it’s simply that they are backward-looking and have no predictive value. Stocks that pay consistently high dividends over the next 20 years probably will outperform the market between now and 2031. The problem is no one has figured out how to identify those companies today.

Companies that have grown their dividends in the past are no secret to anyone, and screening for these stocks in no way guarantees outperformance. (Does anyone buying Fortis think that its widely known record of rising dividends isn’t baked into the price already?) Identifying undervalued stocks is far more difficult than many people admit. Surely amateur investors cannot truly believe that they have special talents in these areas when nine out of ten professionals cannot outpace their benchmarks.

Dividend junkies have a solid track record, and no one should suggest they abandon their strategy if it works for them. However, all investors should remain skeptical of anyone’s ability to consistently pick stocks and time their purchases. It’s always been a loser’s game. Instead, we would all do well to emulate the discipline, cost consciousness and other good habits of dividend investors. No matter what strategy you use, if you can get that part right, you’ll reach your financial goals.

Other posts in this series:

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

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

Dividend Myth #4: You can beat the market with common sense: just focus on blue-chip companies with a competitive advantage and a history of paying dividends.

Dividend Myth #5: It’s easy to build a well diversified portfolio of Canadian dividend stocks.

Dividend Myth #6: Investors who follow a dividend growth strategy will eventually beat the market on yield alone.


  1. Money Smarts Blog January 20, 2011 at 8:44 am

    Great series, Dan.

    I agree that picking stocks is a crapshoot – dividend stocks are no different.

    With respect to Canadian equity however, if a dividend investor loads up a lot of the “common” dividend stocks, it’s very likely that their portfolio will have a moderate resemblance to the TSX60.

    When I quickly look at the top 20 or so of the TSX60 (XIU), at least half are big dividend players. Obviously, they are probably better with XIU, but at least a dividend portfolio is not too far out in left field.

    Great points about the characteristics of a successful investor. I would add savings rate in there as well. Your savings rate has nothing to do with investing skill per se, but I suspect a lot of “successful” investors, were also good savers.


  2. Echo January 20, 2011 at 9:41 am

    I don’t believe dividend investors find the hunt for dividends any more enjoyable than a Couch Potato finding the perfect asset allocation does. Afterall, one of the reasons why you choose a certain method over another is that it interests you more.

    Of course the secret to any good investing track record is patience and discipline. But saying dividend investors believe their method is more exciting is just silly…it is one of the most boring methods of investing out there. Even more so than indexing (IMO), at least for me…I don’t have emerging markets or gold in my portfolio. Just boring old financial and utility stocks for the most part. Not dinner party conversation in the least.

    Investors who get caught up in the excitement are the ones who buy the story stocks like Lulu Lemon, RIM, or Apple…or any IPO (Facebook anyone?), or junior mining stock…often purchasing them well after they are value priced. Sadly these “stories” typically end badly for the average investor.

    I would say that dividend investors are passionate about their approach, much the same as you are about yours. But again it’s the discipline and patience that will reward you in the long run, not the excitement of stock picking.

  3. DRM January 20, 2011 at 10:19 am

    I’m enjoying these articles, Dan. Over the last few years, I have slowly converted into a so-called dividend investor, not necessarily because I think dividend stocks will outperform non dividend stocks, but rather because I think quality dividend stocks offer a safer investment for me. Just as importantly, I want the dividends as supplementary income.
    Dividends are tax friendly, although not as tax friendly as capital gains, but the biggest factor for me is that dividend investing eases the investment risk. In effect, it allows me to park my money in so-called blue chip companies while getting paid 3%-5% per year. I’m not looking for the maximum yield out there because in most of those cases, yield is almost equivalent to EPS, effectively making the investment more risky.

  4. Eric January 20, 2011 at 12:36 pm

    Interest rates are ultra low so it is obvious that investing in dividend stocks is very attractive, but exciting ???

    Dividend stocks were out of favor for a long period, but within 23 years we had the crash of 1987, the asian crisis, the dot-com crash and the housing bubble…..maybe some old boring companies that have the ability to return money to shareholders deserve a place in your portfolio.

  5. Canadian Couch Potato January 20, 2011 at 12:49 pm

    @Echo and Eric: Perhaps I’m wrong and most people don’t enjoy the process of stock picking, following individual companies, receiving dividend cheques, etc. If that’s the case, the only other reasons to engage in this time-consuming behaviour are because you need tax-advantaged cash flow today, or because you think you can earn higher returns than a broadly diversified passive strategy. Or is there something else I’m missing? (I’m not being sarcastic here. I’m genuinely curious to understand the motivation.)

  6. Echo January 20, 2011 at 1:20 pm

    @Cdn Couch Potato
    Ok, I’ll bite. I would like to try and beat the market…especially when it goes sideways for years. Based on historical data the best way to attempt to do that is to buy dividend paying stocks that grow their dividends over time, and to buy them at attractive valuations. Yes, past performance does not equal future success…but nobody has a crystal ball. All we can do is look backwards.

    Can you beat the market with an index? Can you prove that investing with a broadly diversified passive approach will beat a dividend growth approach 20 years from now? If so, please supply the data…I’m genuinely curious to see how much of a long shot it is to beat the market with this approach.

    And please tell me how this is a time consuming approach compared to what you call passively managing your portfolio? I buy, hold, and wait. When I have enough cash to make another worthwhile investment in a value priced stock, I buy some more. I’ve made one trade in the last 10 months.

  7. The Dividend Ninja January 20, 2011 at 1:39 pm

    Hi Dan,

    I’ll take the “Capital Gains Ninja” referral as a compliment. I thought the Canadian Couch Potato was catchy, but the Canadian Potato Ninja might be good too :) I’ll come over and sit on the couch sometime. You talk about the “zeal of dividend investors”, yet I can see you are also very passionate about Index Investing as well – otherwise you wouldn’t be writing this blog.

    And rightfully so, Index Investing is a proven model. I don’t think anyone here would argue otherwise.. or think that the goal is to beat the market. In fact I strongly advocate Index Investing for the beginning investor and as a significant component in anyone’s portfolio.

    I think the answer to your question with Eric and Echo is Active versus Passive, and I think the bottom line is to do with personality. I’m certain most Index Investors do indeed beat the returns of speculators and avergae investors. Since I gravitate to Active investing, I keep a small 5% or less for that and leave my core investments alone.

    However I take exception (all in the spirit of good debate) to the premise of the article that all dividend investors are market timers, and bargain hunters. Most dividend investors do not attempt to time the market – that is just not the point.

    Most of the big dividend investors out there just buy big blue chip companies on a regular basis regardless of price, its just dollar cost averaging. Its great to buy a stock you want at a low price, but that just isn’t always realistic. Likewise as an Index Investor, when you top up your portfolio you are buying more shares or units of what is cheaper, and selling your winners when you rebalance. Active or Passive its the same result – it’s dollar cost averaging the equity component of a portfolio.

    You also fail to mention the point of Assett Allocation. In your article we don’t know if Larry holds 100% dividend stocks, or holds any bonds or fixed income. Asset allocation is by far the most important decision over individual securites. I think it would be fair to say most dividend investors likely have balanced portfolios. And I would think it foolish for any dividend investor to hold 100% dividend stocks! That asset allocation with fixed-income and growth proved beneficial for me in 2008!

    Dan, thanks for writing these articles. Its’ great to see the interest and debate. Keep up the good work!

  8. Eric January 20, 2011 at 1:45 pm

    @Dan: My focus is not on earning higher returns than the market. The major attraction of a dividend strategy is the dividend itself. That is why you have to start early as an investor. After more than 15 years, I have some stocks with yield on cost of more than 8%. I don’t care much about capital appreciation and thanks to the dot-com crisis and housing bubble; blue chip stocks were on sale!

    My portfolio has many asset classes (including dividend paying stocks) and thank you for your blog ; I’ve learned a lot about ETF’s. I recently added VTI & VEU to my portfolio.

  9. Canadian Couch Potato January 20, 2011 at 2:50 pm

    Thanks for the great discussion, everyone. Lots to respond to here, and my future posts will be dealing with some the questions people raise. But a few points:

    @Echo: An index investor will never beat the market. I accept that achieving market returns is so unlikely that it is a useless goal. So the questions is, how can I come as close as possible? The answer is by investing in the entire market at the lowest possible cost. With the mature index funds now available, it is realistic to expect long-term returns of about 0.1% to 0.5% below the market benchmarks.

    “Can you prove that investing with a broadly diversified passive approach will beat a dividend growth approach 20 years from now?” Nope, I can’t prove it. All I can do is point you to the overwhelming academic literature that demonstrates how extraordinarily unlikely it is for any active strategy to outperform over the long term. For the gruesome details, see my recommend book list.

    @Ninja: Yes, the comment was an homage to your blog name, which is one of my favorites! I’m not sure that “Index Ninja” has the same ring. Re: a portfolio of 100% dividend stocks, you and I agree that it’s foolish (or at least riskier than people appreciate), but many, many investors have exactly that. More on this later.

    Re: market timing, many dividend investors distance themselves from this term because they think it refers to huge, frequent moves between cash and stocks. But I am using it to refer to any decision to buy individual stocks now because “it looks cheap” or avoid it because you believe it is “overvalued.” That’s a form of market timing, whether you want to call it that or not. It’s a willingness to believe that you have identified a price anomaly that has eluded everyone else. It is quite different from Ninja’s description of making regular contributions, and dollar-cost averaging regardless of your market outlook, which I believe is much more sensible.

  10. Steve in Oakville January 20, 2011 at 3:27 pm

    At it’s core, this really is a debate about passive vs. active investing. I’ve read so much about these topics, and others strategies, that sometimes my head swims with information. As I’ve commented in other posts, I have split my investments into two equal parts: 50% passive couch potato, and 50% dividend growth. I did this because I truly don’t know what’s going to happen down the road and I figure this is a good compromise because I find logic behind both approaches. I love my passive portfolio because it requires no energy now that I have an asset allocation that makes me happy. I love my dividend growth portfolio because it requires some thought and decision making, it gives me the enjoyment of feeling as if I’m involved in a specific company, just as Dan noted in the post.

    Dividend investing is clearly active though because if you do it, you’ve got to make some very important decisions about stock selection and market timing: First, which company? Let’s say I like the utilities – TransCanada? Enbridge? Fortis? Obviously over the next 20 years, those companies will have different dividend growth rates, different capital appreciation. Which one will be best (or does it matter)? Similarily, do the banks still count as good dividend growers when they haven’t raised dividends in two plus years? If we let those in, what about companies who’ve cut dividends even if they did so for good reasons?

    Second, once I identify a company, when do I jump? From reading Connolly’s blog/website, he believes in using historical yield or Graham values, but it’s not clear to me when to buy. For instance, Royal Bank has a historical yield of about 3.3? It’s now in the 3.7% range – is this enough of a discount? In other words, dividend growth investing from my perspective is definitely not as straightforward as it appears. I don’t find it to be anyway. These decisions, in my estimation, probably stack the odds against me in terms of beating the broad market returns.

    Generally, I agree with Dan in that the strength of dividend growth investing might have less to do with the approach and much more to do with the discipline required to carry out the approach with integrity. Give me a decade or two and I’ll tell you which side won out in my personal portfolio…!

  11. Canadian Couch Potato January 20, 2011 at 3:37 pm

    @Steve: Have you considered a career in diplomacy? :) You’ve clearly found a good balance, and you’ve obviously got an unusually good awareness of your own biases.

  12. Steve in Oakville January 20, 2011 at 3:48 pm

    Ha!! A career in diplomacy? My wife would have things to say about that I’m sure…

    But I did forget to mention, and I have no idea Dan if you’re planning on dealing with this so forgive me if I’m jumping the gun, but does anyone else who’s into dividend growth investing wonder about the future as interest rates rise? We’ve seen a huge surge in articles, books, (and blogs) about this sort of investing, and dividend growth stocks have done wonderfully for a while, but this whole while, interest rates were dropping making a 4% dividend yield very attractive. I wonder if there’s a ‘bubble’ that we’re creating, and if so, am I jumping on at the inflated top? I do think about that sometimes…again, the market timing issue raises it’s head…

  13. Canadian Couch Potato January 20, 2011 at 4:09 pm

    @Steve: I haven’t planned anything on this specific issue, although I will have more to say about investors’ preference for dividend stocks when the yield on bonds and GICs is so low.

  14. Chris January 20, 2011 at 5:46 pm

    @CouchPotato: Regarding your comment “If that’s the case, the only other reasons to engage in this time-consuming behaviour are because you need tax-advantaged cash flow today, or because you think you can earn higher returns than a broadly diversified passive strategy. Or is there something else I’m missing?”

    Although indexing is a big component of my portfolio, my goal in dividend stock purchases is a margin of safety, as Graham and Klarman define it. Indexing is essentially a form of speculation; the only reason one has to believe that indexing will be profitable in the future is because of the historical performance of the strategy and long term economic trends. Dividend stocks, when purchased at attractive valuations (based on fundamentals, not on yield), have fundamentals that you can assess. Strong fundamentals combined with good value gives you some idea of what the future may hold. This is, in a true sense, investing rather than speculation.

    I don’t necessarily believe that past performance is sufficient indication of future performance for large industrialized economies, which is why I can’t go with an entirely index-based strategy. Dividend stocks do give me an assessable margin of safety independent of historical performance. The last 10 years have demonstrated the value of this strategy, while indexing has not done as well. While I expect some reversion to the mean for indexing, it’s impossible to tell which strategy will be more profitable over the next 10 years. (As I’ve posted before, I believe you mischaracterize the strength of what can be concluded from the academic research in favour of indexing.)

  15. Canadian Couch Potato January 20, 2011 at 6:32 pm

    @Chris: Thanks for adding your comments. I think it’s important to be clear what the research says. The conclusion is not “equity markets have returned 10% over the last 80 years, and therefore they can be expected to return 10% over the next 80 years.” Maybe some people believe that is the message, and they would be right to be skeptical of that. Is that what you mean when you say indexing is speculating, or that you’re worried about the future of industrialized economies?

    What the research says is, “The market gives what the market gives, and no one has demonstrated any way to consistently earn above-market returns. Therefore, the investor’s best chance for success is to capture as much of the market returns as possible. The ideal way to do this is by buying and holding funds that mirror the broad market indexes at very low cost.” Well managed index funds can now accomplish this with tracking errors as low as a few basis points.

  16. The Dividend Pig January 20, 2011 at 9:46 pm

    Wow, this has really been a lively debate! I think there are a lot of great points being made by everyone, but for me, I think it’s important that we all settle on the fact that no one knows for sure what strategy will work best in the future.

    For every book I’ve read that cites multiple studies proving passive index funds outperform active management, I’ve also read another that proves dividend investing, or small cap investing, or all bond investing, etc. is the safest strategy for market beating returns. Sometimes we forget that authors/publishers/brokerage houses are trying to sell us something, and of course that something is the most profitable.

    In addition, these studies all have the fundamental flaw of looking at the past. Who knows what will happen in the future? Could anyone have guessed in 1999 the market would be flat for 10 years, and experience two recessions? Or that gold would skyrocket in 2010? For all we know, the best returns in the next twenty years will be from mining stocks. In 2031 there will be a slew of books published that “prove” investing in mining stocks outperforms the indexes.

    For me, the majority of my portfolio is in index funds. Not because I necessarily believe no one can beat the market (though I’m sure if someone could, it would not be me) but because I like knowing I can’t do any worse. I may not win the World Series, but at least I’m still playing in the majors.

    I invest in dividend paying stocks because the type of investing they require (patient and steady) fits my temperament. I also enjoy the challenge, the research, and the game. But they are a small part of my overall portfolio, and I plan to keep them that way.

  17. The Passive Income Earner January 21, 2011 at 12:36 am

    To answer you question “Or is there something else I’m missing?”: for me, the goal is to live from my earned income (dividends, interest, …) from my investments without dipping into my savings during retirement. My parents are doing just that and are being successful. The goal is to get to a point where my income is sufficient for my retirement – I’d love to reach 100K$ in earned income from my investment per year.

    Like many others, 50% of my investments are in dividends, the rest is in fixed income with my company RRSP plan.

  18. Michel January 21, 2011 at 6:20 am

    I really enjoy your articles, and of course the comments! For me, it’s all about buying good dividend paying stocks (the best 4 or 5 in each sector), and hold them forever unless a fundamental change occurs. I’ve had TD since the early nineties. I wish I new when to buy them (at value prices) but I never know when. For example, when will it be a good time to buy Manulife? I’m a passive investor because I do not trade in and out of them. I don’t like bonds or bond funds/ETF. I don’t like preferred shares. I like the good strong dividend stocks. Fo a little more balance I buy good canadian REITS. I use DRIPS, so I automatically buy the same stocks every month or quarter. The strategy works and I slept well during the 2008 meltdown!

  19. Canadian Couch Potato January 21, 2011 at 7:21 am

    @PIE: Thanks for clarifying. I think most of us want to build a portfolio that will generate income in retirement. What I’ve never understood is why it is desirable to focus on income-generating investments for decades in the accumulation phase. Shouldn’t the focus be on total return, in order to build the largest possible nest egg before retirement? Then when you need to start drawing down the portfolio for daily expenses, you can switch to a mix of income-generating assets, whether that is dividend stocks, bonds, an annuity, or some mix of these.

    If you are planning to build a portfolio that will generate $100K of income indefinitely, how much do you think you need to save? Most financial planners would suggest that it would be about $2.5 million, based on a 4% withdrawal rate. Is your target in that neighborhood?

  20. The Passive Income Earner January 21, 2011 at 11:15 am

    I did some all out equity for growth with mutual funds and stocks and it was miserable … I am very satisfied with dividends both through a trading account and through Transfer Agents for small contributions. I have some rules based on the different sectors and what to hold in each, for example, my Transfer Agents investments are mostly utilities where I buy 50$-100$ monthly and I benefit from the fractional shares.

    As for how much, I at least need 1.5M$. I am not sure yet what my bond strategy will be … I may switch to preferred shares. Many guarantee the price purchase after 10 years for a fixed yield but there is absolutely no growth.

    As for generating 100K$ … I can’t say I have the winning formula but my goal is to bank on the recurring increased dividends to accelerate my growth and later on use it as income. I have 1 year under my belt with dividend investing and so far so good but I never loose track that I need to compare my return and if I need to adjust, then I will.

    This year, I should be able to generate 5K$ in dividends only and that’s with about 60K$ of dividend investments. Mathematically, it’s working out well, but as my portfolio grows and I diversify, I think this will change.

  21. Canadian Couch Potato January 21, 2011 at 11:52 am

    @PIE: When I started writing this series it wasn’t to talk people out of a dividend strategies altogether, but it was to call attention to some questionable math I see bandied about.

    I’m not sure how a $60K portfolio can sustainably yield $5K, which is 8.3%. And there is no way one can draw down a $1.5 million portfolio at $100,000 a year (adjusted for inflation in each year after retirement) without a very high risk of running out of money. That’s a 6.67% withdrawal rate, about double what is usually recommended for a balanced portfolio.

    I am concerned that a lot of people who expect their dividend portfolio to fund their retirement are relying on hopelessly unrealistic expectations.

  22. Echo January 21, 2011 at 12:16 pm

    @Cdn Couch Potato
    I think PIE is referring to his $1.5M portfolio being able to generate $100,000/year in income through dividends (that was my interpretation anyways). He wouldn’t run out of money because he wouldn’t be touching the capital. And assuming the dividend growth stocks continue to increase their dividends, that income would be growing each year to offset inflation (and then some).

    I’m not so sure that achieving a 6.67% yield on the market value of that portfolio is realistic, but a 4% – 5% yield would certainly be ($60,000 – $75,000). I don’t think it’s unreasonable to expect a dividend portfolio to fund retirement when you factor in the compounding over time of dividend growth, re-invested dividends, along with any new money added.

  23. Money Smarts Blog January 21, 2011 at 12:28 pm

    One of the misconceptions about dividends is that they are immune from any kind of safe withdrawal rate discussion.

    This is not the case.

    If you are going to follow a 4% withdrawal plan (ie indexed for inflation each year), that includes ALL withdrawals from the account (dividends, interest, capital withdrawals), not just withdrawals due to the sale of securities.

  24. The Passive Income Earner January 21, 2011 at 1:29 pm

    Echo is correct. I mean that a 1.5M$ portfolio would generate 100K$ in income to live from without touching the capital. My parents have been doing it for 26 years. There is definitely examples of that. My parents retired at 46 and have been living from their dividend income ever since without touching their RRSP until now since they are 70. They even contribute to their TFSA.

    My 60K$ dividend investments yielded 3.7K$ in 2010 with investments added during the year. With a full year with my current investments and yield, it will yield nearly 5K$. So I will make that. Is that sustainable for 25 years. I’d say no. It will average down but it’s a good start. With dividend increase, it should keep up with inflation.

  25. Canadian Couch Potato January 21, 2011 at 1:47 pm

    The research by William Bengen (widely followed by financial planners) found that investors can safely draw down 4% of their retirement savings, adjusted for inflation each year, with a very high likelihood of making their portfolio last until they die. He also found that a 5% withdrawal rate brought a 30% chance of outliving your money. As Money Smarts says, this includes drawing down capital.

    PIE, your retirement plan begins with a withdrawal rate of 6.67% in the first year and makes no inflation adjustments. Either your real income will decline every year, or you will adjust it for inflation and stand a very high chance of draining your portfolio before you die. Your math is flawed, and I urge you get some professional advice if this is your retirement plan, because it is fantasy.

  26. The Passive Income Earner January 21, 2011 at 2:27 pm

    I still don’t think we are talking about the same thing. I am not withdrawing anything … That’s the idea behind the income from dividend investment.

  27. Canadian Couch Potato January 21, 2011 at 2:42 pm

    Nope, we’re definitely not talking about the same thing.

    Here’s a math problem for you. Dividend Dave has bought dividend-growth stocks for 30 years, and when he retires on January 1, 2040, he has amassed $1 million in his RRSP, which includes 500 shares each of 30 different companies. He plans to live off this portfolio for the rest of his life.

    Passive Pete used an index strategy for 30 years and miraculously built his portfolio to the same amount: when he retires on January 1, 2040, he too has $1 million. That day, he sells his entire portfolio and buys 500 shares each of the same 30 companies that Dividend Dave owns. Now the two of them have exactly the same portfolio.

    Explain how Dividend Dave’s safe withdrawal rate can be higher than Pete’s.

  28. Canadian Capitalist January 21, 2011 at 3:30 pm

    @PIE: “I’m not withdrawing anything…”

    Think about this exercise.

    You are earning 6% from your portfolio.
    The stocks in the portfolio cut their dividends by 33%.
    You dip into your capital to maintain your spending.

    Ergo, you are withdrawing from your portfolio.

    I’m a bit surprised we are even having this discussion in light of what happened to dividends in the previous bear market. S&P 500 dividends peaked at $29 at the end of 2008. Dividends today? $22. A 25% drop.

  29. Steve in Oakville January 21, 2011 at 3:59 pm

    @CPP and maybe CC: I’m confused too. PIE seems to be saying that if he only uses the dividend income his portfolio spins off, he won’t need to sell off his capital. Let’s forget about the 1.5million spinning off 100K a year because that’s way too optimistic in my opinion. But let’s say I amass the $1 million portfolio like CCP’s example uses and I’m able to generate about 4% in dividend income. If I only need that 40K in dividend income to supplement my other retirement monies, won’t my $1 million portfolio remained untouched?

    Is the difference of opinion related to inflation? For instance, if dividend increases don’t match inflation, then eventually that 40K will need to be topped up from capital. But let’s say that inflation and dividend increases stay in lockstep, is it wrong to think that I won’t need to tap into capital?

    Obviously, if dividends get reduced, that’s a nasty surprise, but let’s also assume that they won’t get reduced…

  30. Echo January 21, 2011 at 4:10 pm

    @Cdn Couch Potato
    I think that Dividend Dave holds his dividend paying stocks outside his RRSP and is not required to withdraw capital from his portfolio in retirement.

    @Cdn Capitalist
    Rather than using the broad S&P 500 as your benchmark, you should just look at the dividend growth stocks (if that’s possible). How likely is it that an entire portfolio of dividend growers cut their dividends by 33%? Out of the aristocrats only MFC cut their dividend in ’09.

    From ’08 to today MFC has reduced their dividend by 50%. Ok, fair enough. But over the same time frame ENB raised dividends 48.5%, EMA 36.8% and BCE 35%. Bank dividends have stayed the same. So despite the rare dividend cut from one company, your dividend income will still rise.

    I’m not cherry picking the best examples either. CU – 21%, T-16.67%, FTS-16%. This was during a huge recession. Income was still rising.

  31. Canadian Couch Potato January 21, 2011 at 4:48 pm

    @Echo: Clearly whether it’s an RRSP or not changes everything. There is no question that if you hold your nest egg outside an RRSP in retirement, then it absolutely makes sense to hold Canadian dividend stocks, which I acknowledged in the first post in this series. Of course, whether that’s the best tax strategy over a lifetime will vary hugely between individuals — the dividend investor will pay a lot less tax in retirement, but would have payed far more tax during the accumulation stage. The dividend gross-up can also cause issues for retirees near the OAS clawback thresholds. If you’re talking only about taxes, there are so many variables that it comes down to individual situations.

    Maybe I’ve taken for granted that most people build their retirement portfolios in an RRSP, and that many RRSP investors use dividend-focused strategies despite the absence of any tax benefit. I should have been more clear about that.

    @Steve: Your withdrawal rate is perfectly reasonable at 4%. The annual amount you withdraw is adjusted for inflation, so if you start with $1 million and inflation is 2% per year, you can safely take out $40,000 in year 1, and $40,800 in year 2, $41,616 in year 3, and so on. (These models assume a balanced portfolio of stocks and fixed income.)

    I’m calling a truce for the weekend. :) Thanks for a great discussion, everyone.

  32. Canadian Capitalist January 21, 2011 at 5:04 pm

    @Echo: S&P 500 dividends are obtained from the group of stocks in the index that pay a dividend. Therefore, S&P 500 dividend income is a good proxy for what the average dividend investor experienced.

    Dividends from the TSX did not fall to that extent. We did have some cuts — MFC and in income trusts primarily — but not to the same extent as the US. We may not be so lucky next time.

    @Steve in Oakville: If dividends (a) are not cut and (b) keep pace with inflation, then spending all the dividends is safe. But these are not safe assumptions to make. The key variable is the rate of withdrawal, not what form the withdrawal takes place. At 4% whether you withdraw as dividends, capital gains or interest, your portfolio will likely outlast you in retirement. But you will also likely tap into capital.

  33. My Own Advisor January 22, 2011 at 7:56 am

    Great discussion for round # 2.

    I’d like to pick up on something Mike said as commenter # 1 – “with respect to Canadian equity however, if a dividend investor loads up a lot of the “common” dividend stocks, it’s very likely that their portfolio will have a moderate resemblance to the TSX60.”

    That’s my strategy as a dividend investor.

    In looking at an even smaller sub-set of choice companies, when I look at XDV, for example, I’ve decided I’m better off working to own those stocks outright than pay anyone any management fee ever. Will I ever own all 30 holdings in XDV? No. Half? Probably. And really why not, since most Canadian banks, utilities and telcos have paid dividends for about 70 years before I was born and I’m confident they’ll pay dividends for another 20 more as I work and another 30 more when I retire.

    Canadian dividend-paying stocks are most definitely tax advantaged when left unregistered. Until the rules change, it will forever make sense for me to keep some of those investments, there.

    I don’t consider dividend investing to be “the be all, end all” even though I’m very passionate about it and write quite a bit about it. Rather, for the reasons above and many more, I’m focusing on this strategy because it is working for me. This doesn’t mean indexing doesn’t have its place in my broader financial plan – index investing is not an inferior choice.

  34. Chris August 17, 2016 at 3:56 pm

    Hi Dan, Thanks for the articles.

    I am a dividend investor because I believe that I will gain tax-advantaged cash flow today and in the future. At retirement the return on my Canadian dividend stocks may not be higher than the TSX, but I will not need to sell equity (or as much) to create a desired level of cash flow. This leaves the asset (stocks) to keep rising over time. To me Dividend investing is about cash flow today and in the future. My mother in law is enjoying these benefits today: an income and a rising portfolio size at the same time. She is also a very disciplined investor.

    Having said that I also believe in Index investing, balanced portfolios and global diversification. My equity is 50% dividend investing and 50% index. They are both great in my view.

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