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I disagree with an expert, buying what you know makes sense

A few weeks ago, Larry Swedroe wrote in a CBS News Moneywatch article that buying what you know is a bad investment strategy.

I disagree with that actually.

For those who might now know who Larry Swedroe is, he is the Principal and Director of Research for Buckingham Asset Management and an accomplished author who has published 11 investment books, the most recent one, The Quest for Alpha.  He’s a very bright guy, he’s legendary actually.   I had the pleasure of meeting Larry last year here in Ottawa.  When it comes to passive investing or investing in general, Larry knows his stuff.   However, when he made the claim “buy what you know” is a bad investment strategy, I took notice and dared to disagree.

I think buying what you know can be an excellent strategy.

First, let’s go to the article and to some of the findings the article referenced.

The Moneywatch article referenced a recent study entitled “Do Individual Investors Have Asymmetric Information Based on Work Experience?” to put the “buy what you know” theory to test.  Some of the findings of this study are summarized below (my thoughts follow in italics):

  • Individuals failed to diversify their human capital, overweighting stocks in their industry of employment.

I suspect this is not uncommon but this seems more like a diversification issue than a “buying what you know” issue.

  • Individuals didn’t earn abnormal returns when trading professionally close stocks. On a one-year level, a portfolio of stocks related to investors’ areas of expertise had a negative alpha of about 5 percent (meaning investors performed worse than the benchmark).

I think a one-year window for investment analysis purposes or to suggest a trend, is a very short window.  Actually, the window is barely open to take a decent look.

  • Individuals traded excessively in professionally close stocks, showing that investors felt more confident trading stocks of companies they knew.

In my opinion, trading is not investing.  Going another step further, I think excessive trading is more akin to gambling.  I’m not a financial pro by any means but I believe investing is correlated to making a financial plan and sticking with it.  This plan can include stocks, bonds, a savings account, debt repayment or any combination of these. 

  • Advanced degrees didn’t provide any benefit. Those with a Ph.D. didn’t generate abnormal returns.

Not sure how advanced degrees have anything to do with buying what you know but I can only assume there is a bias to being overconfident because you are a subject matter expert if you hold a Ph.D.

If the findings from the study want to suggest investors have a false sense of security when they invest in the stocks of their employer, I can support that.  These individuals may be overconfident owners of their company based on the industry they work in.  Yet buying what you know can make great sense as long as you are following good portfolio management practices – buying a diversified set of what you know over time.

Many mutual funds and exchange-traded funds (ETFs) have done this diversification for you, for a fee of course, which makes things much easier since you have instant diversification.  To this point, dividend investors have a challenge that index investors do not have, they are taking some risk upon themselves to diversify their portfolio over time.

The following companies have been dividend stalwarts for decades.  These companies also comprise the top holdings of many dividend and equity exchange-traded funds (ETFs) in Canada.  In the  name of buying what you know, I figure if the biggest funds and ETFs in Canada hold these companies, if I’m going to own stocks directly then I should own them too.  Here are some examples of what many Canadian dividend and equity funds own as part of their top holdings:

  • Major financial companies (TD Bank, Royal Bank, Bank of Montreal, CIBC, Bank of Nova Scotia, Manulife)
  • Major energy and utility companies (Enbridge, Suncor, Canadian Natural Resources, TransCanada, Fortis, TransAlta)
  • Major telecommunications companies (Bell Canada, Rogers, Telus, Shaw)

If you owned these companies, you might be surprised that through buying what you know, you’d own about 50% of the equities in the TSX by market value.

In closing, I definitely agree with Larry Swedroe that diversification is the only free lunch in investing so you might as well eat a lot of it but buying what you know can make great sense as long as diversification principles are applied.  Otherwise, if you’re going to put your eggs in one basket just remember it’s one basket.

Filed in: Goals & Planning, Index Investing

39 Responses to "I disagree with an expert, buying what you know makes sense"

  1. I think that if you’re going to buy individual stocks at all, you need to know a lot about what you’re buying. It only makes sense. Buffett suggests that we should only invest within our circles of competence. It doesn’t matter how big that circle is, as long as we know its parameters. Larry, I think, was trying to discourage people from buying individual stocks, when suggesting this. But I believe that people should know as much as they can about their businesses before buying. If you’re buying a stock, I feel strongly that you should understand the products, use the products, speak to distributors of the products, know how easy or difficult it is for the company to maintain a competitive advantage, while thoroughly understanding the annual reports and the flow of money over the previous five years (at least). Most stock investors think they know the company by just using its products and reading an analyst’s report on Valueline, or checking out earnings data online. But I think this is a sloppy shortcut. I think one of the reasons I’m no longer a stock picker is because of the inordinate amount of time I spent researching businesses (including the businesses I owned). If you own companies, you must know as much about them as possible. To be fair to Larry, he was discouraging (I believe) stock picking because he doesn’t think the average investor (or even the exceptional investor) can beat a diversified portfolio of indexes over a lifetime of stock picking. I tend to agree with him….most people certainly can’t. But for goodness sakes, if you are going to buy an individual stock, pick something you know very well, and then learn, learn and keep learning…about the business and its competitors. It’s the only habit/discipline that will give you a long term, fighting chance.

    • Hey Andrew,

      Thanks very much for your comment! Really happy to hear from you!

      I liked your comment Andrew, “…if you’re going to buy individual stocks at all, you need to know a lot about what you’re buying. It only makes sense.” I feel the same.

      I can see where Larry is discouraging many investors away from individual stock ownership and instead into indexes. I get that because overall, the averages are in favour of passive management over active management. However, I think it is possible for an “average” investor to build a diversified set of dividend-paying stocks “buying what you know”. I recognize my post was a little controversial, but I strongly feel this is the case.

      How is everything going Andrew? BTW – I listened to a few of your radio interviews on the CBC and really enjoyed them :)

  2. Hey Mark,

    I agree with you. If someone is diversified, buys what they know, doesn’t trade frequently…I think they can do just fine. Controversial posts are the most enjoyable to read and write, I think. But your post isn’t too controversial. I’m sure you’ll find far more supporters than detractors. I’m glad you liked the interview. I recently did one on a Malaysian radio station which you might get a kick out of. Here’s the link: http://bfm.my/2012_03_01_andrewhallammillionaireteacher.html

    Keep up the great work! I’m actually trying to convince Kevin http://www.investitwisely.com to do a pushup workout with me, via skype right now, but he hasn’t gotten back to me yet. Let me know if you ever want to do that. Our first face to face meeting would be on skype, doing pushups and suffering in a brotherhood that only sweat and pain and can unite.

    • Thanks for writing again Andrew.

      Again, I’m not knocking indexing, I mean, I do it myself! What I struggle with is either the title of the article or the premise that buying what you know can’t work. It absolutely can – but like everything else in investing, you need to be diversified.

      Maybe I’m against the title of the article, it’s misleading. The study looked at “professionally close” stocks and no doubt there is bias there. People tend to have a sense of superior knowledge about the company and industry they work in, which is understandable. What I struggle with is, if you’re putting your eggs into one basket then you’re putting your eggs into one basket! It’s like putting all your chips on the table at a casino, the house will eventually win.

      From a diversification perspective, indexing is a hands-down winner because all the work is done for you. I don’t argue that. I argue that holding a basket of diversified companies whether you are “professionally close” or not can work if you also keep fees low, stick with your long-term plan (don’t trade) and keep your emotions in check.

      A very wise Millionaire Teacher reminded me of all this stuff!

      As for Skype, yeah, we should. I have your address. I will email you this weekend and see if we can finally set up a time!

  3. Moneycone says:

    There may be some truth to what Larry says. At least from personal experience. During the dotcom boom, a lot of us techies thought we had the technology space figured out and invested like gods. It didn’t take us much to figure out how a dotcom company worked. We knew the buzzwords, made more sense to invest in the new economy.

    The party ended. The rest is of course history! On the other hand a retiree with a good mix of bonds and stocks with no understanding of Cisco’s business model would’ve weathered the storm pretty decently.

    • Yes, but I still have concerns with the mantra. All booms eventually bust. I wasn’t invested in individual stocks during the tech boom, but I was invested in stocks during The Great Recession. When things tanked, I bought more. Maybe I just got lucky and my luck will run out. Hard to say since I don’t know what the future holds, but I can see your point for sure, overconfidence is deadly.

      I’m just trying to keep it simple, and maybe I will get burned for it eventually. Like I wrote above in another comment, if I buy what I know, I’ll own Enbridge that heats my home, Rogers that provides the internet I’m writing on now, and Telus that provides my cell phone service. Last time I checked, these are some of the most successful dividend-paying companies, let alone companies, in Canada.

      Your comment about “knowing less” is a very good one. I wonder if you need to pour over tons of annual reports to be successful, or just own what all the mutual funds own? Thoughts? ;)

  4. Larry Swedroe says:

    There are few problems with this line of thinking

    a) Because you know something about the company doesn’t mean that you know more than the market knows, which is all that matters. The odds of you having more information that is relevant to value than the big institutional investors who set prices are probably close to zero. Suggest reading Investment Mistakes Even Smart People Make and How to Avoid Them.

    b)There is a large body of evidence that individuals confuse familiarity with safety. If they are familiar with something, they believe it is safe. Thus they overweight the stocks of their employers and local companies, which makes no sense. In fact it is failing to diversify their labor capital

    c) You must separate information from value relevant information—knowing something about the company is worthless if it is known by the market and thus already built into prices. That is the mistake investors typically make, they fail to understand the difference between value relevant information and just information.
    A good explanation of the difference is in Wise Investing Made Simple in story on sports betting.

    d) Note the stocks individual investors buy go on to underperform and the stocks they sell go on to underperform.

    e)If you want to learn why dividend paying stocks is not an optimal strategy, just basically a poor value oriented, low beta strategy with insufficient diversification see my blog posts on that subject.

    http://www.cbsnews.com/8301-500395_162-57383053/the-dangers-of-dividend-paying-stocks/?tag=cbsnewsMainColumnArea

    http://www.cbsnews.com/8301-505123_162-57384410/dont-rely-on-dividend-strategies-to-pick-stocks/?tag=cbsnewsMainColumnArea

    http://www.cbsnews.com/8301-505123_162-57393240/why-you-should-be-wary-of-stocks-that-pay-dividends/?tag=cbsnewsMainColumnArea

    And will leave you with these quotations to consider:

    People overconfidently confuse familiarity with knowledge. For every example of a person who made money on an investment because she used a company’s product or understood its strategy, we can give you five instances where such knowledge was insufficient to justify the investment.
    —Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes

    Any individual who is not professionally occupied in the financial services industry (and even most of those who are) and who in any way attempts to actively manage an investment portfolio is probably suffering from overconfidence. That is, anyone who has confidence enough in his or her abilities and knowledge to invest in a particular stock or bond (or actively managed mutual fund or real estate investment trust or limited partnership) is most likely fooling himself. In fact, most such people—probably you—have no business at all trying to pick investments, except as sport. Such people—again, probably you—should probably divide their money among several index funds and turn off CNBC. —Gary Belsky and Thomas Gilovich, Why Smart People Make Big Money Mistakes

    Finally an efficient market makes it very difficult for sophisticated investors to exploit unsophisticated ones because the market price is the best estimate of the right price, that also means that the unsophisticated ones when they buy and sell are also trading at the best estimate of the right price. Their problem is emotions get in their way and they trade too much and don’t diversify because they buy what they “know.”

    • Hi Larry,

      Thanks for taking time to respond to my article. I think it’s great what the internet can do, bring ideas and people together to share perspectives or disagree sometimes. I think either is healthy if done constructively because it enables the learning process for everyone.

      a) Because you know something about the company doesn’t mean that you know more than the market knows, which is all that matters.

      I respect that because no one person can know more than thousands or millions of others. Which is exactly why I believe owing a diversified basket of dividend-paying stocks is not unlike indexing – and both strategies can be successful over time.

      b)There is a large body of evidence that individuals confuse familiarity with safety. If they are familiar with something, they believe it is safe.

      Maybe I’m not very safe with my investments and I have too much risk in my portfolio because I don’t own enough stocks yet – but I question whether if I own the same stocks millions of indexers have in their portfolios, if I’m really being that risky.

      c) You must separate information from value relevant information—knowing something about the company is worthless if it is known by the market and thus already built into prices. That is the mistake investors typically make, they fail to understand the difference between value relevant information and just information.

      I’m just learning the ropes of investing, and learning more every year, but if value is already built into the price then I actually don’t bother playing that game. I try to buy my stocks when the price goes to a 52-week low or lower. To me, that’s an indication the company is less expensive and on sale compared to before. I am probably missing something but that’s my plan which seems to be working, so far.

      d) Note the stocks individual investors buy go on to underperform and the stocks they sell go on to underperform.

      What if you don’t sell stocks and what holding period are you comparing for buyers? If my holding period is 25 years, I suspect a bunch of dividend income should offset the underperformance.

      e)If you want to learn why dividend paying stocks is not an optimal strategy, just basically a poor value oriented, low beta strategy with insufficient diversification see my blog posts on that subject.

      Larry, I will definitely have a read of your blogposts.

      http://www.cbsnews.com/8301-500395_162-57383053/the-dangers-of-dividend-paying-stocks/?tag=cbsnewsMainColumnArea

      http://www.cbsnews.com/8301-505123_162-57384410/dont-rely-on-dividend-strategies-to-pick-stocks/?tag=cbsnewsMainColumnArea

      http://www.cbsnews.com/8301-505123_162-57393240/why-you-should-be-wary-of-stocks-that-pay-dividends/?tag=cbsnewsMainColumnArea

      In closing and summary, I’ve never had any issues with indexing. I index a big part of my portfolio actually. I think it makes sense because I cannot possibly beat the market consistently over the long-run “picking companies”. The issue I have, is the “buying what you know is a bad strategy”. I personally don’t think it is because it’s the way I invest and my dividend income is rising every month because of it. The proof is in my results. As I mentioned in a comment above, everything I’ve ever read about successful investing, can be distilled down to:

      staying invested, keeping costs low, keeping your emotions in check and being diversified.

      I do not see how investing in dividend-paying stocks is a big departure from that successful recipe.

      I look forward to any comments you have on this response, or any article in the future Larry. I enjoy visiting your site and the expertise you share. I’ve become a better investor because of this.

      Cheers,
      Mark

  5. @Moneycone
    Good point MoneyCone. I guess some financial history should be part of high school to prevent such things. Many of those tech companies themselves were OK, if they were making net profits and had PE ratios that were acceptable. But not understanding PE ratios and earnings…that was probably the missing link. People didn’t know (even those working in the industry) that a PE ratio of nil or 60X earnings+ was a very bad sign.

  6. “Buying what you know” maybe a lot easier in Canada than the US, our market is only a fraction of a fraction of what the US market is. For example we only have 5 real big banks and they all follow a very similar trend, there are only 3 real big telecommunication companies….this same can be said about almost any industry in Canada. So it only makes sense to buy what you know, because we are very familiar with these companies in one way or another.

    I think Larry’s title was a bit misleading and not clear enough. The study mainly looked at “professionally close” stocks (meaning stocks of companies in fields related to their profession), and this has been an issue in behavioral finance for sometime. In this case we are not talking about investments you have researched, studied and know, but investments you “know” because you are familiar with them through your employment and profession. People tend to have a sense of superior knowledge about the company and industry they work for. They believe they have superior insight and can benefit from it, this is the real issue. I don’t think Larry or any other investment profession would recommend you buy investments you know nothing about, just to be conscious of your possible biases.

    • You’ve got some fair points Ray, probably easier in Canada because we have a high concentration of companies in a few sectors to choose from, meaning much less consumer products companies and major technology companies in our selection basket.

      We rely on energy and our resources and everything falls from there.

      I think Larry’s title was a bit misleading and potentially more for headlines. I will mention as much when I respond to him.

      “Professionally close” stocks has been a behavioural issue for some time, yes, but this isn’t a bad strategy only if you don’t diversify. Putting all your chips on the table, for anything in life, and you’re bound to lose to the house.

      People do tend to have a sense of superior knowledge about the company and industry they work for, which is fine and fully understandable. What I struggle with is the generalization that all investors should index because of this.

  7. stamperitis says:

    Don’t forget the all in one basket case also being that if your job sector is hit hard in the economy and all your assets are in the same sector you’re being hit with a double whammy. Probable job loss and possible major loss in equity in your portfolio. Can’t remember which finance book I read that in but it’s too true. It’s part of diversifying.

  8. Think Dividends says:

    100% Agreed MOA.

    Buying an Index that is currently 77% Financials/Energy/Materials does NOT make sense!!!

  9. SPBrunner says:

    If an investor is overweight in their sector I agree that this is diversifications problem. I think you should probably start with what you know and then move on.

    Not only is a one year period a short period, but some sectors earn investors more than other sectors, so it would also depend on the sector as to what is being earned.

    I agree that trading is not investing. Some people trade stocks and some people invest in stocks. They have very different outlooks on the market. To tell you the truth, I know more people who made money investing than in trading.

    I think one requirement for investing is to have common sense. I know a lot of very smart people, but common sense and smarts do not always go together.

    If your job, pension and investing depend wholly on your employer this can cause problems. I know that some companies give employees a good deal when buying company stock. I have also advised people I know who have this benefit to know what the rules are and if they establish a nice portfolio of company stock, they should sell some when they can and invest outside their company (or industry).

    To have a diversified portfolio, you need to know a number of different companies. Getting to know a small number of different companies is not that difficult.

    • @Susan,

      Thanks for your detailed comment! Always great to read about your perspectives and 30+ years of dividend-investing experience.

      I see where Larry’s article is coming from, you can easily have overconfidence based on the profession you work in. However, that is not a buying what you know flaw, that is a diversification flaw. Maybe I’m hung up on the terminology?

      For example, I know Coca-Cola makes money, lots of it. It advertises everywhere and I have a bunch of it in my fridge. This is what I know. I wouldn’t put all my financial eggs in this basket, but if I can ever afford to buy more Coca-Cola, I will because I understand it.

      Maybe my dividend-income has risen over the years because I’m overconfident, lucky or not smart enough to know any better. When stocks tank, I buy more because that makes sense to me. When I have new money, I buy different companies I don’t yet own. I suspect based on Larry’s comments, I’m not sophisticated enough to buy my own stocks. I guess time will tell. At least if I fall flat on my face, everyone can read it here first :)

  10. MOA I completely agree with you! I saw Larry Swedroe on BNN a couple of weeks ago. I wasn’t very impressed. His arguments against “stock picking” were completely academic , and I thought a little stretched especially when it got into global diversification as the alternative. That always seems to be the answer against buying dividend stocks – diversification. Actually after seeing this segment on BNN, I decided it was time to start moving the index funds into dividend stocks. I’m glad you wrote this post. ;)

    So lets look at this: Buy as you know is a completely usesless strategy. This means that MCD the global dominator in fast food, Starbucks the international coffee giant, Coca-Cola, Johnson and Johnson, my cell provider Rogers, Canada’s largest bank the Royal Bank, and Procter and Gamble are all terrible investments – because I know these companies ;) huh?

    I’m better off buying a basket that follows the TSX and includes companies like RIM, Yellow Media, Superior Plus, and a whole pile of other companies I wouldn’t touch with a ten foot pole is a better investment, than “picking” long term solid stable companies. ;) huh?

    @Andrew Hallam

    Andrew goes without saying I have the utomost respect for your advice and wisdom – as everyone else here does. I have always enjoyed conversing and discussing ideas with you. So I wouldn’t argue with your track record and advice here. :)

    Where I have a problem though is in saying that you really have to understand the balance sheet of a company and know it inside-out before investing in it. To be fair I don’t think that’s realistic, even my accountant who knows this stuff (and does audits) says much of its impossible to know. There are very few people who know how to rip balance sheets and income statements apart, and know how to dig the real information out of this. I don’t really think you have to know Johnson and Johnson inside and out to invest in it, or other large blue-chip companies for that matter? Sure you have to look at some basics – no doubt about it. But their solidity in decades of paying dividends and their economic moats speak for themeselves.

    I would agree with you for smaller cap companies however, where the yields and debt are higher. One should be careful and do their due-diligence here. If there is even one red-flag stay away. At some point I have more faith buying companies I know and understand, that do have decent fundamentals and pay dividends, than a basket of stocks I don’t have a clue what a third of the companies are. That’s just may take on it Andrew;)

    Cheers, well done MOA!

    The Dividend Ninja
    (now with even more dividends!)

    • Wow, thanks for the detailed comment Ninja!

      I’m glad you provided the response you did, otherwise, I’d have to call you the Index Ninja!

      I’ve met Larry and he is a great guy, a very smart financial guy, much smarter than I will ever be!

      The challenge I have, is the “only this way” mantra. With indexing, you take the good stocks and the duds but at least you don’t have to think about it very much. Maybe I’m invested in some duds. Maybe my entire dividend portfolio will eventually tank. I don’t know, but I do know is this, the more I diversify, the more I own established companies that have paid dividends for decades or generations…I’ll take my chances and I bet I’ll do just fine.

      If I buy what I know, I’ll own Enbridge that heats my home, Rogers that provides the internet I’m writing on now, and Telus that provides my cell phone service. Last time I checked, these are some of the most successful dividend-paying companies, let alone companies, in Canada. What am I missing here?

  11. @stamperitis
    Don’t forget the all in one basket case <– that made me laugh LOL :)

  12. Echo says:

    The problem with “buy what you know” is that for every positive example we can provide (Coke, P&G, Tim Horton’s, etc), the detractors can give similar negative examples (Kodak, Nokia, RIM, etc).

    What I found interesting in one of Larry’s posts was that he says don’t rely on a dividend strategy, yet he goes on to show the following:

    “For the full 30-year period, the fast-growing dividend group provided an annualized return of 11.1 percent versus 10.7 percent for the CRSP total market index.”

    If the dividend growth strategy provides similar returns as a global index (a bit higher, in fact), at a slightly higher risk, that sounds like a wash to me.

    I think the indexing-zealots should keep their focus on the high-MER actively managed mutual fund investors and drop this crusade against the DIY dividend investors.

    • Great comment Echo.

      I guess the thing with RIM at least, they never paid a dividend.

      I’ve never had any issues with indexing. I index a big part of my portfolio actually. The issue I have, is the “it has to be this way” narrative. Everything I’ve ever read about successful investing, can be distilled down to:

      staying invested, keeping costs low, keeping your emotions in check and being diversified. I do not see how investing in dividend-paying stocks is a big departure from that successful plan.

  13. @My Own Advisor

    Apperantly you won’t beat the averages, that is the argument for indexing (as you know). The other argument is you will get lower returns with dividend stocks than by buying the overall market etc. etc.

    The problem I personally have with indexing are the “academic” arguments for it. The model is valid. The problem I have with it is also the “its this way or no way” approach – I agree. I won’t rule out indexing, but I think I will sleep easier at night holding a few big cpmpanies than all of the market.

    It will be interesting to see what happens five years down the road, if and when interest rates do indeed increase. When .. All I know is by then I will have a regular dividend stream of income, probably some decent capital appreciation, and a smoother ride with some bonds (and maybe GICs at that time). Who really knows? The one thing I do know is I won’t be relying on the market for my returns, I will be relying on solid blue-chip companies that as you point out have been paying dividends for decades.

    Cheers and great post man!

    The Dividend Ninja

    • @Ninja,

      It depends what you define as “average” :)

      The indexing model is very valid, actually the most foolproof method of investing there is.

      The problem I have is the mantra “it’s this way or no way.” If my dividend income doesn’t continually increase for the next 5 years, I will be the first person to eat crow.

      Thanks for your comments!

  14. Hi Mark
    Quite an honour to have Larry Swedroe drop by! I’m not sure the market is as omnipotent as LArry seems to think. Institutional and professional investors have their constraints and biases too. And I think information filters out at different speeds, sometimes instantaneously, sometimes over weeks or months. For example, employees can often tell that their company’s next quarterly report will be a good or bad one.

    • Hey Larry,

      Yeah, it was very nice to have L. Swedroe stop by and offer his perspectives. I suspect professional close stocks have their baises, and no doubt it might be hard to avoid, given how well employees think they know their company, but I don’t think owning company stock is necessarily a bad idea. Rather, only owning company stock is a very bad idea. Given everything I’ve ever read or heard, I will never do it.

      Thanks for stopping by. I hope to be over to CBO this week to see what you have in store.

  15. I agree with you Mark. I personally only invest in what I know….its my number one rule.
    It doesn’t matter if its the greatest stock in the world, if I don’t understand it, I don’t buy it.

  16. James says:

    MOA,

    What is your goal of building a portfolio of individual stocks over picking an index? Do you feel you will outperform, is it for tax purposes, is it for fun, etc?

    I personally have gone the index route because I do not think that I will be able to outperform the index and the goal of my portfolio is to maximize my returns.

    You keep repeating that an investor will be successful with a diversified basket of stocks (which is likely true), but is the most successful that you can be?

    • @James,

      Thanks for your questions. Geez, you’ve really got me thinking now don’t you?

      Here are my rationales for investing in dividend-paying stocks:

      1) For part of my retirement money, I’m going to rely on income from a non-registered portfolio. Dividends from Canadian companies can provide significant tax advantages, as you might already know. Interest income is taxed at your marginal tax rate. For me, as I build wealth and assets, I want it tax-advantaged.

      2) I enjoy acquiring shares at discounted prices. Many of the biggest dividend-payers in Canada offer discounts associated with their dividend reinvestment plans (DRIPs). For example, CIBC, 2% off. Enbridge, 2% off. Emera, 5% off. In the past, I was able to increase my portfolio size more quickly via share-purchase plans (SPPs). Now, I just DRIP stocks with my discount broker.

      3) I am fortunate to have a DB pension from work, which I consider a “big bond”. For me, I feel I can take a few more equity risks with buying and holding dividend-paying stocks. Some other people might not be in this position, and would prefer to index only. I would totally understand that approach.

      4) I’m not trying, really, to beat the market. I’m investing in established companies that pay dividends for the steady income, and using that income to either pay down debt or invest in other areas. With indexing, the yields aren’t as juicy and the income isn’t as much accordingly.

      5) Dividends are an extremely important part of investment returns. Dividends typically prop up a portfolio in a market downturn. On the upside, over the past 100 years, 40% of stocks’ total return has been from dividends. Furthermore, studies have shown that over a long-period of time, 30+ years, dividend-paying S&P stocks in particular rose far more than non-dividend paying stocks over the same period. .

      In closing, I think indexing makes perfect sense. I do it myself. However, for part of my portfolio, I see no reason why dividend-paying stocks can’t provide ample income and capital growth for me, in a tax-advantaged way.

      What do you think James? Would like to hear from you again anytime to discuss.

  17. James says:

    @My Own Advisor

    Thanks for the reply.

    I still have trouble understanding your true motivation, which seems to boil down to interest.

    1) You say that divies are tax-advantaged. However, that would apply to the divies you get from a canadian index fund too, so I don’t see how that puts you ahead.

    2) You speak of the DRIP discounts, however you DRIP in a discount brokerage and you don’t receive those discounts.

    4+5)You say that you are not trying to beat the market but then say that dividend paying stocks have gone on to beat the market over the past number of years.

    I hope you do not find that I am attacking or criticizing as that is not my intention. I have been fascinated by how people are almost religious in their dedication to dividend investing. I guess one could say the same thing about indexers.

    As for your entry points, do you feel that controlling when you purchase initial positions into stocks has been a positive or negative. I say this because I have been fortunate or lucky with my individual stock picks (before I switched to indexing) but I realize that a large part of this was due to luck. On this note, do you feel that the timing aspect of your picks will represent a drag on your long term portfolio returns?

    And on the topic of DB pensions, my wife and I are fortunate to also have them and because of this, have only a 20% bond allocation in our portfolio.

    • Hey James,

      Thanks for writing back. It’s great to have a healthy discussion about this stuff and investing in general.

      1) Yes, both types of divies are tax-advantaged but most Canadian equity ETFs don’t yield 4% or more like my dividend portfolio is. If they do, I haven’t found them yet.

      2) Regarding DRIP discounts, I do get them in my discount brokerage account.

      Regarding my other points, it is true, I’m not investing in these companies to “beat the market” per se but the reality is, these companies tend to keep pace with the market. With indexing, you get the star performers and the laggards. With many dividend-paying stocks, as long as you are willing and the companies, can, ride out market storms, you’ll be successful. I know too many people that own 20, 30, 40 or more stocks and can live off the dividends because of it. It was they started their own investing in companies 25 years ago. I hope to be there in 20 more years just like them. Did they bomb on some picks? Absolutely. Did they hit some home runs? Absolutely. I index part of my portfolio and always will. Indexing is not the only way to invest, just a great way to invest which is safer and immediately more diversified than most other types of investment strategies.

      I do not find you critizing me at all. Your comments are respectful and constructive and I’m willing to chat about this stuff, in this way, all day long :)

      About my entry points, I’ve been pretty good or just plain lucky. I bought a few of my holdings when the market tanked in 2008-2009. I sweated every second of the purchase process but it has been worth it, to see where these companies are today.

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