How to Beat the TSX (BTSX)

How to Beat the TSX (BTSX)

Ever growing income. Beating the index. Sounds like fiction, right?

This is how you Beat the TSX in today’s post.

The long history of how to beat the TSX (BTSX)

Many years ago, I had the pleasure of interviewing Ross Grant, about his book, his writing gig at Canadian MoneySaver, and for the purposes of this post: his investment approach including Beating the TSX (BTSX).

You can check out that older interview here.

For those that don’t know or haven’t heard of Ross, he is another early Canadian retiree who helped amplify the BTSX approach pioneered by Dr. David Stanley.

Over the years, Ross has stepped back from writing books, articles for Canadian MoneySaver and more – but thankfully Matt Poyner from Dividend Strategy carries on the BTSX content and mantle – very comprehensively and prolifically I might add!

(I’ll provide a link to Matt’s outstanding site below.)

I’ve gotten to know Matt a bit over the recent years, and I figured Matt would be “the guy” to talk to when it comes to BTSX, how it remains very relevant for investors if not more so now than ever before, and how more importantly this approach can apply to your financial independence future.

Matt, welcome to My Own Advisor and it’s great to connect again.

Thanks so much, Mark. It’s clear we’re both passionate DIY investors who are here to help other Canadians.

You bet.

Matt, for those that don’t know about you, your bio, background story…how did you get started with investing?

Happy to share, Mark. My background is painfully ordinary – I was no teenage stock market prodigy. I started with mutual funds in my mid-20’s, but like most DIY investors, the high fees, poor performance and finance industry conflicts of interest got me looking for a better way. It didn’t take long for me to fire my big-bank advisor and move all our money to index mutual funds – ETFs weren’t really a thing yet and I lacked the confidence to buy individual stocks.

Then I came across a series of articles published annually in a small Canadian investing magazine called Canadian MoneySaver (see above!) that built a portfolio of blue-chip dividend-paying stocks using a simple, evidence-based method that even I could understand as an annual investor. The method as you well know was called Beating the TSX and the author, David Stanley, a professor at the University of Guelph, had been diligently recording the performance of the method for about 20 years. As discouraged as I had been at paying 2.5% annually for high-fee mutual funds, BTSX had been beating the index by about that much on average for twenty years.

I started using Beating the TSX to select dividend-paying stocks for the Canadian portion of my portfolio and haven’t looked back. It has continued to outperform the index for over 30 years and has helped many Canadians achieve financial independence faster than they otherwise would have.

No doubt! Let’s dive into BTSX. As an introduction, what is the BTSX strategy for those that might not be familiar to it. Why does this approach work so well?

Beating the TSX is based on the Dogs of the DOW strategy in the U.S. but has performed much better up here. Here is the method in a nutshell:

1. List the stocks on the TSX 60 Index by dividend yield.
2. Select the top ten yielding stocks.
3. Purchase these stocks in equal dollar amounts and hold for one year at which point the list is regenerated and the process is repeated.

You might think that this method results in a lot of buying and selling, but it doesn’t for two reasons. First of all, most investors who use the method will hold stocks that have dropped out of the top ten as long their dividend appears safe. They’re usually off the list because of price appreciation and are still great companies to own.  Second, the BTSX list is remarkably consistent with only 3 to 5 of the holdings changing year over year.

Why does it work so well?

I’ve thought a lot about this because the results really are quite good. I think there are a variety of reasons.

First, research shows that dividend-paying stocks outperform non-dividend-paying stocks by a wide margin.  According to research by RBC, since 1980 Canadian dividend-paying stocks have had average annual returns of 9.1% vs. only 1.2% for non-dividend-payers.

Second, among dividend stocks, there is evidence showing that both yield and dividend growth are indicators of superior long-term returns. Most BTSX stocks tend to display both of those characteristics: high-yield and good growth.

Third, and perhaps most importantly, the Beating the TSX method accesses the value factor. Value has been shown in academic studies to be a robust predictor of long-term outperformance. BTSX does this because the method is based on dividend yield: as stock price goes down, yield goes up. Beating the TSX investors, therefore, tend to buy companies when they are on sale.

I’m with you Matt, and I think the third factor is the most important. As yield inches up, it’s a bit of value play and signal that prices are depressed which can be a great time to buy.

I recently wrote about dividend-paying stocks, as a hedge for inflation protection.

Do you feel the same way? Why might BTSX stocks in particular help investors fight inflation?

I enjoyed your article, Mark. Inflation is on everyone’s mind. I think the best hedge against inflation is the ability to earn more money.  You can do this by working more or by letting dividend-paying stocks work for you. This is where dividend-growing stocks really shine, and many of the blue-chip high-yielding stocks in Beating the TSX are also dividend-growers.

Take 2021 as an example. The total dividend yield at the beginning of 2021 was a generous 6.13%. If you were lucky enough to have $1 million evenly invested across those stocks, you would have enjoyed a passive income of $61,300 for the year – not too shabby. With the dividend increases, however, that income rose to $66,400 = a 9% increase. That’s $182 of income every single day for doing nothing, income that increased more than inflation.

Over the last ten years, 73% of BTSX stocks have raised their dividends in any given year, 21% held steady, and 6% cut their dividend. As unpleasant as dividend cuts are, they are rare and potentially avoidable by passing over stocks without a long history of consistent dividends. Another Canadian dividend personality, Henry Mah, has a book entitled Your Ever Growing Income. That sums it up well, I think.

I believe you’ve included a review of his book and interviewed him as well.

(Mark, I have! I’ll provide those links to readers below as well.)

Henry is passionate dividend investor for sure – I’ve also enjoy seeing his passion in those books.

Matt, I believe BTSX can also be a very tax-efficient way to invest – can you help explain?

Dividends can be extremely tax-efficient because of something called the Canadian Dividend Tax Credit. This is essentially a government incentive to invest in dividend-paying companies.

Say you have a couple who want to draw $100,000 from their investments per year. If each of them received $50,000 in bond interest, after paying income tax, they’d only be left with about $78,600. If that money was taken as capital gains, they’d be left with about $94,600 – not bad. But if they each received $50,000 in dividends, their total tax bill would only be about $1,200, leaving them with $98,800. That’s $4200 more than what you’d get from taking capital gains. I don’t know about you, but I’d rather see that money in my account than the government’s!

In non-registered accounts, dividends are always more tax-efficient than regular (interest) income and are even more tax-efficient than capital gains with an income under $100,000. In registered accounts, it’s the total return that matters.

Some of the tax efficiency, vis-a-vis compounding, could be lost in non-registered accounts if there is a lot of turnover. That is a big reason Beating the TSX investors tend not to sell good dividend-paying companies just because they drop off the list in a particular year.

I’m one of them Matt, I buy and hold and hold these BTSX stocks myself – and have clobbered the TSX in the process. That said, total returns matter, the sum of dividends and capital gains, year-over-year.

What’s your take on the dividends vs. indexing debate?

Then, diving deeper: how do you invest Matt? Do you believe in both dividends for ever growing income along with the hope for capital gains from ETFs?

At the end of the day, it’s all about total returns for sure, Mark. 

It is a myth that, beyond favourable tax rates, dividend distributions are fundamentally superior to capital gains “distributions” (i.e., selling stock that has appreciated in value). The evidence for this goes all the way back to a 1961 paper by Miller and Modigliani, and is generally known as the “Theory of Dividend Irrelevance”.

I welcome the dividends vs. indexing debate. Listening carefully to the criticisms of dividend investing made by intelligent indexers has made me a much better investor. Frankly, there are a lot of dividend investing myths that have been perpetuated, ideas that sound good in theory but don’t stand up to scrutiny. The irrelevance of yield on cost is one that comes to mind. (Mark: agreed.)

I believe in evidence-based investing. There is a ton of evidence that index investing is incredibly effective at capturing risk-adjusted returns. It is also so simple and easy that almost anyone can do it, thereby avoiding high MERs and advisor fees. On the other hand, we also have over 30 years of evidence to support Beating the TSX. There’s room for both.

Personally, I use Beating the TSX stocks for the majority of my Canadian equity exposure, but I’ve added in some other blue-chip dividend-paying stocks from other sectors that are not represented well on the BTSX list like consumer staples, industrials, and materials. These stocks all have a good history of dividend growth.  One might also look south of the border to invest in other sectors. I’m aiming for the glorious trifecta of dividend yield, growth and capital gains.

Personally, I use index ETFs for my international exposure.

Like you Mark, owning XAW (iShares Core MSCI All Country World ex Canada Index ETF) gives me exposure to the rest of the world with a single purchase, all for 0.22% per year, which is a good deal in my books.

Emerging markets are more speculative but have underperformed for a long time and I think they’re going to shine eventually. As such I own XEM (iShares Emerging Markets ETF) and a little of another lesser-known but interesting ETF, EMQQ, that excludes the less-profitable, more risky state-run enterprises.

Ha, so many dividend investors (including myself) use XAW for extra diversification – it’s simple, but it works! Let’s talk about BTSX results, over long-investing periods. What has been the performance of BTSX vs. the TSX – does it really work in practice?

Last year, our BTSX portfolio returned 41.7% vs 27.8% for the benchmark TSX 60 index – that’s a 13.9% outperformance (total returns).

As of the end of 2021, the 30-year average rate of return using the Beating the TSX method was 13.13%, whereas the benchmark index rate of return was 10.46% over the same time period.

I’m not aware of a single mutual fund in Canada with a track record of such out-performance. In fact, BTSX has outperformed the benchmark over the last 3, 5, 10, 20 and 30 years.

Source: Dividend Strategy.

What this means in real terms is that $10,000 invested using the BTSX strategy 34 years ago would be worth $369,752 today. That same $10,000 invested in the benchmark index would be worth only $173,859 – a 113% difference.

Source: Dividend Strategy.

It’s remarkable to me that a simple rules-based method that anyone can use can yield results like this, but the data is the data. There are certainly years when BTSX underperforms – 2020 was one of them – but the long game has been extremely profitable and I suspect this will continue for this fundamental reason: Beating the TSX buys big dividend-paying and growing stocks when they’re on sale.

Love these charts and the long-term results!

Lastly Matt, what stocks are on the BTSX list for 2022? How can folks follow the performance of these stocks with you in 2022 via your site and newsletter?

To be scientific about our performance numbers, we create a new portfolio on January 1st every year. Here is the 2022 BTSX portfolio:

But readers who invest at other times of the year need more up to date data, so I also maintain a list of the entire TSX 60 index, listed by dividend yield, in addition to a real-time list of BTSX stocks on my website.  

DividendStrategy.ca is the only place you can find this information whenever you need it.

Thanks for the opportunity to share “Beating the TSX” with your readers, Mark!

I know you discuss many of the stocks you own, and buy, but if your readers are interested in more information about BTSX, more focused-BTSX articles, and solutions to many other issues that self-directed investors face, I would encourage them to go to DividendStrategy.ca.

I look forward to sharing my content with readers.

Awesome Matt.

Folks, there you have it.

BTSX is a long-term winning strategy and is likely to be great approach going forward for all the reasons Matt and I write about. I hope to have Matt back on the site in the future, to discuss how he manages his portfolio in early retirement and/or any big changes he sees in the BTSX approach as he monitors the methodology over time.

I second the subscription to Matt’s site – it is excellent.

Thanks for your readership.

Mark

Related BTSX Reading:

Here is my primer on the BTSX strategy – with thanks to some of Matt’s content of course.

Read on to learn about some stocks to own for ever growing income. 

Buy the book Your TFSA Compounder from Henry Mah who shares a similar story about BTSX stocks to own.

There are the huge benefits in owning a 6-Pack Portfolio.

Like Matt, I believe these are some of the dividend stocks and ETFs built to last for your portfolio.

Can you Beat the Index? Yes, and Ross Grand proves it.

Learn more about the Dividend Tax Credit and leverage it to your advantage here.