Reader Question – Why don’t you just buy dividend ETFs?
Every week, I receive many requests and questions from readers in my inbox.
Thanks for those by the way and keep those questions coming folks.
One of the more frequent questions to My Own Advisor is:
Why don’t you just buy and hold a dividend ETF for Canada instead of individual stocks?
Good question.
Before I provide you with my answer, a bit about dividend ETFs and why I do like them.
Why dividend ETFs are great
First of all, like many other ETFs, I like the transparency dividend ETFs provide. Within a few clicks of a mouse, I can see what every single holding is in each of these popular products:
- iShares Dow Jones Canada Select Dividend ETF (XDV)
- iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ)
- BMO Canadian Dividend ETF (ZDV)
- Horizons Dividend ETF (HAL)
The high transparency of dividend ETFs certainly trumps the “black box” approach to many other investment products such as some mutual funds.
Secondly, I like dividend ETFs because of their modest money management fees. The fact is, dividend ETFs are cheaper than many actively managed dividend mutual funds. Many mutual funds buy and sell stocks frequently in an attempt to beat the market. Buying and selling frequently incurs costs, and those portfolio costs are passed on to you. Instead of all this trading, investors can simply focus on buying and holding an ETF to follow a dividend index or a broader benchmark index like the S&P/TSX Composite Total Return Index. Many dividend ETFs have management fees in the neighbourhood of 0.60% or less. Compare that to TD Dividend Growth Fund (at just over 2% as of December 2011) and RBC Canadian Dividend Fund (at about 1.8% management expense ratio (MER)), and you’re saving a bunch of money in management fees.
Good on you to do so. Fees matter!
Thirdly, dividend ETFs are low effort. If you’re going to invest in individual stocks, you need to spend some time understanding these companies. I read annual reports and follow metrics like yield, payout ratio, earnings per share, cash flow and company debt to name a few. Buying stocks means another investor is selling this company so you need to make time to understand what you are buying and when. Dividend ETFs don’t have this complexity. Dividend ETFs have built-in diversification. You can own dozens of Canadian dividend paying stocks rather easily in one fund.
Why I prefer individual dividend paying stocks
All this said, dividend ETFs can be good products but there are a few reasons why I prefer to own stocks in Canada directly where I can, and I intend to buy and hold many more of them in my investing future.
First of all, some dividend ETFs have specific criteria and measure some constructed indexes I don’t fully agree with. For example, the iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ) “has been designed to replicate the performance of the S&P/TSX Canadian Dividend Aristocrats Index®”. For a company to qualify as a holding in this product the company must have increased their ordinary cash dividend every year for at least five consecutive years, among other criteria as well. This is sound criteria but it also means some stellar Canadian companies that have great histories of paying dividends are not included in this product. Bank of Montreal is just one example that comes to mind. BMO has been paying dividends every year, uninterrupted, since 1829. Therefore, while CDZ has some great companies in it, it does tend to leave a few solid companies out.
Secondly, as a consequence of the management criteria; these products are designed and marketed to investors after all, so not all dividend ETFs are created equal. To meet my investment objectives I would need to own a couple dividend ETFs to get what I want. For example, XDV is particularly weighted heavily in Canadian financials. Owning a bunch of Canadian financials is not diversification.
Thirdly, on the topic of fees, I save money. By owning individual dividend paying stocks instead of just dividend ETFs, I don’t pay money management fees. Yes, I miss the low-cost, built-in diversification with ETFs but if you get the point of owning 25+ dividend paying companies in Canada, maybe some of the same ones listed in the popular dividend ETFs like XDV and CDZ, you’re indexing by proxy at this point and you can forget the 0.60% MER I referenced above. You can essentially build your own dividend index fund in Canada and index invest the rest of the world.
Fourth and finally, I control the portfolio and the portfolio turnover. My long term goal is to grow my dividend stock portfolio to the point where I can live off part of the income in retirement, with many investments across many industries. I’ve been on this journey for a few years now and the progress is starting to show. By owning individual stocks in Canada I’m in control of the portfolio. I can weight the companies however I wish. By choosing a dividend ETF, I would not have as much control because these products often weight their holdings by market capitalization and have predefined turnover periods; the reconstitution is done for me so I wouldn’t know how many companies I will indirectly own until the ETF is rebalanced. Another benefit, I can take advantage of the discounts these companies provide for dividend reinvestments (DRIPs). Believe it or not, many established Canadian dividend paying companies provide you with a discount for DRIPping shares, some up to 5%.
Why don’t you just buy dividend ETFs?
In closing, dividend ETFs can be great but they are not perfect products – especially in Canada. I’ll never be able to replicate the entire composite index which is why I will always have a two-pronged approach to manage my portfolio:
- owning some broad market, low-cost ETFs, and
- some dividend paying stocks.
Thanks to all the readers who have emailed me this question…I hope I have provided you with an answer.
Comments on my reasoning? Comments on comments? Have a question for My Own Advisor? Fire away and maybe, your question will be part of a future blogpost!
Mark
My name is Mark Seed - the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I'm looking to start semi-retirement soon, sooner than most. Find out how, what I did, and what you can learn to tailor your own financial independence path. Join the newsletter read by thousands each day, always FREE.
You’re right, it’s definitely not the same feeling as owning these companies in an ETF. If it were, there probably wouldn’t be as much need for BNN Market Call!
For years I’ve wanted to go with just an ETF portfolio but I find it’s very hard psychologically to do so. I feel like I want to hold some stocks too, not just a want but kind of a need in a way..maybe it’s FOMO of having a big winner at some point.
Currently I hold a 3:1 ratio of ETF to Individual Stock Holdings..trying to make it greater but it’s a challenge psychologically to do so when its your portfolio. When it is someone else’s portfolio, people recommend 100% ETF portfolios all day long.
“When it is someone else’s portfolio, people recommend 100% ETF portfolios all day long.”
Ha. How true. I suspect very few people who tout indexing are actually are full on indexers – meaning they only own low-cost funds.
Thanks for the answer Mark. Nice to get an honest, accurate reply instead of a generalization with no work done to figure it out.
At the end of the day, if we are not beating our benchmark, why do we invest actively at all? I think it gives us meaning in life, allows us to enjoy a bit more volatility without much additional risk. (To paraphrase Nassim Taleb, “if we did not have volatility, there would be not point in living.” from his book Antifragile) Also, if we do not admit we like brands for our clothing or brands of sports teams, maybe we like to identify with brands of stocks? ETFs are the generics but stocks are the brands that give us more of a visceral feeling of affiliation. If this were not true, why would these companies spend time in marketing to make cool logos and ads with their company name?
And finally, we probably invest a bit in stocks becuase its a fun hobby with the chance of outperformance even if it is relatively minor.
You make an interesting point about affiliation. It’s interesting because I drive to work and I see banks, telcos, etc. and I think “I own part of that”. I’m not sure if I would have the same connection via ownership indirectly via an ETF.
Will I always own individual stocks? Probably a few. It really depends on my income goals/investing goals, other. Hopefully my decisions are putting us on a good path but I have every intention of using U.S.-listed ETFs more as I get older for investing. Examples include VYM or HDV or IDV or VXUS.
Until CDN banks, telcos, utilities, other stop increasing dividends – then I’ll continue to own them. 🙂 Cheers.
Question, If you back-tested when you started investing and added all money into XIU or XEI for instance (instead of Canadian Dividend paying stocks) what would the difference be in investment experience? Would it be relatively minor or significant? I think investors like to invest in individual names because they like the novelty experience. I don’t think they do it because they have strong knowledge doing so will lead to significant outperformance.
Also, the “fee” argument of not paying a management fee to hold individual stocks but having to pay one for ETFs is a minor point because the yearly fees are likely much lower than other non-essentials people generally pay for with disposable income.
Interesting you asked, but I am beating XIU (my benchmark for my CDN stocks) by about 1%. So, is that out-performance worth it? Maybe not when I think about it.
Also, the “fee” argument is minor, I agree. Unless you own over $100k in stocks it’s probably not worrying about ($180 in fees per year) using XIU as a management fee example. When you get closer to $500k in stocks, fees still do matter though. Thoughts?
@Bernie, Totally agree. Once one has identified a select group of solid DG stocks, than one only has to invest in those, buying when the price is right to get the most income possible. And one does not have to carry all the other ones that make up the etf. Interesting that most div etf,s only hold a small% in utility stocks, like cu, FTS & ema.
I happen to own a number of utilities, I see them as cash cows: CU, FTS, EMA, AQN top my list.
The major reason I prefer to own the actual dividend stocks vs the dividend ETF is that I invest for dividend growth. I pick stocks that have good track records of increasing their dividends. Dividend ETF’s have very poor records of increasing distributions. They are just as likely to decrease them as they are to increase them.
For me its dividend growth rather than just dividend.
It sounds like individual stocks are definitely the way to go. Since I’m just starting to get into investing, maybe some ETFs are still a good idea to limit the amount of constant research I need to be doing. Then once I get more comfortable I can focus on individual stocks.
@Jeremy,
It is for me. I will always own a few ETFs, and probably have at least 50% of total portfolio in ETFs, but the rest will be in dividend paying stocks. I see no reason to pay people fees when I can own the same stuff myself.
Excellent post Mark, while your explanation makes total sense I’m lazy when ti comes to the divvy stocks. I prefer to own ETFs for the long run as I wouldn’t want to keep a close eye on multiple sectors.
Thanks Mich. Don’t get me wrong, I’m lazy as well, I bet we own many of the same ETFs 🙂
Hey Mark, great post! 🙂
The main reason I would prefer to hold dividend stocks directly is simply yield. You will get a higher yield by holding the dividend payers directly than through an ETF. I can hold big solid conservatice blue-chips and still get a 3.5% to 4%+ yield. The yield’s are pretty low for XIU ond XIC in comparison. Just buy the 5 or 10 top holdings that these ETFs hold and your set IMO!
What I have a problem with are ETFs that go for the higher yield by using high yield stocks to get the return, and follow a yield weighted index. CUD is a great example of this:
http://www.dividendninja.com/claymores-new-dividend-etf-cud
There are a lot of stocks in that ETF I wouldn’t want to own, since weighting by yield results in higher risk for a higher return. (people forget that risk in this case means share price declines).
Cheers!
The Dividend Ninja
Of course yield is good, but so is capital appreciation. On the comparison, yes, individual dividend stocks pay more than XIU or XIC but you are not as diversified as you know. That said, we are totally aligned here: you hold the top-10 or top-15 stocks in the big ETFs and I don’t think you can go wrong. You do go wrong if you sell though 🙂
The weighted index annoys me as well. This reminds me these are financial products, with rules to follow, which for a buy and holder of blue-chip companies makes little sense.
Thanks for the comment! I look forward to watching your dividend portfolio take shape.
not being a very good accountant, what would be the most informative, easily understood statement to give me an overview of a company?
Stan