How I built my dividend portfolio…and how you can too
Inspired by my friend’s post this is how we built our dividend portfolio…and how you can too!
You might already know from my site I take a two-pronged approach to investing:
- I own 30+ companies from Canada and the U.S., companies that reward investors through consistent dividend payments every month and quarter, most of them increase their dividends every year, and,
- I own a few low-cost Exchange Traded Funds (ETFs); these funds provide diversification and near-market returns. Dividends are great but never a guarantee!
Why dividend investing?
Not everyone loves dividends like I do but that’s OK. Personal finance is personal. Some financial gurus claim index investing is the greatest thing since sliced bread and any desire to buy what you know makes no sense whatsoever.
There are many reasons why I love dividend investing, as part of total investing return. Here are just a few of them:
- Dividends are easy to understand. I invest, I stay invested, and I get paid for doing so. Pretty simple. It’s tangible money I see coming into my account every month. It’s money that grows over time thanks to reinvested dividends. It’s money we can use (eventually) to pay for any expenses we need.
- Dividends can help fight inflation. As consumer prices rise, as the cost of living rises, the companies that deliver our products and services rise along with them. Many of companies I own have a habit of increasing their dividends over time given they are making more cash every year. Some companies are making so much cash they can afford to raise their dividend every year. Those are the companies I try and invest in. When was the last time you worked, did nothing, got paid AND got a raise in the same year?
- Canadian dividend paying stocks are tax-efficient. With my RRSP full of mostly U.S. assets, and more low-cost ETFs over time, I tend to keep Canadian dividend paying stocks in my TFSA and inside my non-registered account. In a taxable account Canadian dividend paying stocks are eligible for a dividend tax credit from our government. This means taxation on dividends are favourable, it is a lower form of tax; lower than employment income and interest income.
Why index investing?
As much as I love dividends I know the future is always cloudy.
Dividends while expected are never guaranteed.
Nobody can predict the financial future with any accuracy. Besides, dividends are just part of an investor’s total return. This is why for extra investing security and in hopes of long-term capital gains I index invest the rest of my portfolio outside of Canada. There are a few reasons why indexing is a great way to invest, these key ones are important to me:
- With indexing I don’t have to worry about any dividend stock selection. Should I own Fortis or Emera? Should I own TD Bank or Scotiabank? Doesn’t matter. Via indexing I can own hundreds or thousands of stocks from around the world for a few bucks per month in fees. That brings me to point #2.
- Owning thousands of stocks from the U.S. can cost less than $100 per year for every $100,000 invested. That’s peanuts.
- Transparency rules. With a few clicks of a mouse, I can look up the holdings, cost structure, distribution information, tax information and long-term performance of my ETFs.
Why the slight bias to dividend paying stocks?
Dividend investing, if executed well has the potential to deliver market returns AND some sustainable income. I love the idea of passive income – it helps me stick to our financial plan. I love the psychological benefits of seeing cash flow into my account. It helps me stay the investing course when the market tanks or corrects.
With dividend investing, I also have the potential for capital gains for many of my stocks.
That’s win-win. Total returns do matter!
Here’s how I’ve gone about building my dividend portfolio to date…and how you can too…
Step #1 – Consider using dividend metrics
Passive dividend income is great but rising dividend income over time is even better. This means I don’t just blindly buy companies that pay dividends. I use a few metrics to screen for my portfolio holdings. Here are some popular ones:
- Dividend growth and dividend history. I like companies that tend to grow their dividends every year. I also like companies that have paid dividends for decades or generations.
You can also start your screen from Canadian and U.S. dividend champions or aristocrats.
iShares CDZ is a Canadian Dividend Aristocrats Index ETF. It holds Canadian companies that have increased their ordinary cash dividend every year for the last five years.
Typically, U.S. dividend aristocrats have increased their payouts to shareholders for the last 25 consecutive years. I recall at the time of this post there were about 51 or 52 such U.S. companies in that list – which is updated every year.
- Dividend payout ratio. I like companies that aren’t sacrificing all their cash to reward shareholders. I mean, share buybacks are good for shareholders too! Therefore companies that have a modest payout ratio are companies I tend to focus on.
- Cash flow. I have an affinity to companies that grow their earnings and cash more over time. Here is a simple example below; Royal Bank.
- Modest yield. I think this is one of the easiest metrics to use. This metric is a measure how much a company pays out in dividends as a percentage of its share price.
Calculation: Annual dividends / price per share = yield
Example: BCE annual dividends = $2.40 / $60 = 4%.
I think you want to own companies that have a low-to-modest yield. We prefer owning companies that yield between 3-5%. Our holdings include Canadian banks, utilities and telecommunications companies and more. When it comes to yields – higher yields (anything over 6%) could be warning sign for trouble – they are a concern for me anyhow. I try to avoid investing in high-yield companies.
Beyond common stocks there are also Real Estate Investment Trusts (REITs) you could own.
Step #2 – Consider owning what the big fish own!
Beyond the metrics above, here’s the obvious: consider owning what the big mutual funds and ETFs own. If these stocks have been good enough for a multi-billion-dollar fund for the last decade or more they might be suitable for you.
This is essentially skimming the index. I’ve done this with ETF XIU over the years.
Step #3 – Consider diversifying by sector
Even if owning all the Canadian banks stocks might have seemed like a good idea in the past, it may or may not be as fruitful in the future. Again, the future is always unknown. So consider diversifying your dividend paying stocks across various industry sector – including industry leaders in those sectors.
Here is the sector breakdown of the TSX using iShares ETF XIC as a proxy for the broad Canadian market – at the time of this post:
Image courtesy of BlackRock.
This means your Canadian stock portfolio may include a few companies in each sector:
- Financials such as banks (examples: Royal Bank, TD Bank) and life insurance companies (examples: Manulife, Sun Life) and more.
- Energy companies like Suncor and Canadian Natural Resources; energy distribution companies such as Enbridge or TransCanada or others.
- Material (and Resource) companies like Barrick or others.
- Communications companies like Bell, Telus and Rogers to name a few.
- Utilities companies like Fortis, Canadian Utilities, Emera, Brookfield Infrastructure Partners, Algonquin Power and many more.
You get the idea.
Full-on disclaimer alert! Such a list above could be your starting point for your investment research and portfolio considerations. Even though I may own some of these companies above this list is not a recommendation for any purchase. Your mileage may vary!
Here is the sector breakdown of the biggest 500 companies in the U.S. market:
Image courtesy of BlackRock.
The same principles to Canada can also apply to your U.S. stocks. You can consider owning the top holdings in each sector as part of the U.S. market (e.g., information technology, health care, consumer discretionary).
Although I own a few U.S. stocks I have a bias to owning indexed ETFs within our portfolio to own hundreds of U.S. and international equities for a low fee. I personally feel our Canadian market is very concentrated and dominated by a few companies. That means it’s a bit easier to pick stocks for a buy and hold approach. At least that’s my thinking to date…
The U.S. market is more balanced and more difficult to select stocks accordingly that may or may not beat the market index.
Why don’t you just own dividend ETFs?
With all this talk about individual stock selection and holding some indexed ETF products, then why don’t I just own dividend ETFs? Great question and I’ve answered this a few times on my site, most notably in this post.
To summarize here are the key reasons why I don’t own Canadian dividend ETFs at this time:
- Some dividend ETFs have criteria I don’t fully agree with.
- Most dividend ETFs have a modest fee, I prefer not to pay it.
- I cannot control the stock weightings using a dividend ETF.
Full-on disclaimer alert #2! Your investing objectives including your risk tolerance are probably not the same as mine. Therefore you might want to consider dividend ETFs or simply plain-vanilla ETFs for your portfolio. Although I find the concentration of the Canadian market easier to select and hold stocks from I’m personally considering owning more U.S.-listed ETFs over time. Your mileage may vary!
You can read about some of my top U.S. dividend ETFs for your portfolio here.
How I built my dividend portfolio…and how you can too!
Many years ago I decided to ditch the mutual fund industry and begin my DIY investing journey. I did this to keep more of my money and give less away due to money management fees.
Years ago my wife and I decided to hold a number of Canadian stocks directly for passive income, own a few U.S. dividend aristocrats for U.S. income, and then own a few U.S.-listed ETFs for extra diversification. We remain committed to that plan today.
But we’re far from done yet…
One of our big financial goals is to own a $1 million dollar portfolio someday for an early retirement. It’s certainly a dream-like goal but we are getting closer to it.
We’re getting there, despite some mistakes now and again because we’ve developed a plan we could stick to, and we have done so for many years. Meaning: plan the work, work the plan. We’re halfway to realizing our early retirement dreams at the time of this post. Thanks for reading and I look forward to your comments as we continue the second half of our journey.
Got any questions about our long-term goals? Our progress to date related to our portfolio building journey? What about the changes we are considering including owning more U.S.-listed ETFs over time? Comment away – I’m happy to answer any questions.