I’ve read dozens of personal finance and investing books that tout the merits of indexing investing.
It’s all true.
To be clear, the trend towards low-cost, indexed investments has been great for retail investors.
I’m a huge fan of this approach and it’s a big part of my investment strategy – read more here.
Indexing works on many fronts: it is not overly time-consuming, investing costs stay low, investors obtain diversification, and investors can ride market-like returns.
I do believe however (because I invest this way myself) that index investing is not the only way to go. There are degrees of active and passive investing for one. Just because you own a low-cost Exchange Traded Fund (ETF) doesn’t mean you can’t have some core and then explore.
For my explore, I own a number of dividend paying stocks.
Second, the equity market functions in part because of price discovery. I’m not suggesting you trade, for from that, but you need to realize the market decides every day what assets are worth. Without this bartering system we wouldn’t have much of a market.
Third, although owning an indexed product holding 250+ stocks within the TSX Composite Index is helping your diversification, you’re really concentrated in Canadian financials, energy companies, and material companies.
Where is all this leading to?
While I believe and practice index investing I also believe in some active stock selection because you can add companies and sectors to augment your passive investing approach.
Value from Dividend Advisor
Indexing is great but I do not want 10% of my Canadian market exposure in telecommunications, real estate and utility companies. This is the allocation I will get from these sectors if I index invest. I want more.
So I manage my own portfolio. I do my own investing research. I do my own portfolio monitoring. I do my own portfolio rebalancing. I don’t pay an advisor to do my work – I am My Own Advisor. This DIY approach may also work for others.
Some folks along their DIY path might want help – this is why TSI’s Dividend Advisor was created.
I got a chance to talk to the team at TSI recently to learn more about this new service and how it might help your portfolio selection.
Thanks for the time. First of all, how did Dividend Advisor come about?
Dividend Advisor grew naturally out of our investment philosophy. One of the cornerstones of our approach is to “invest mainly in well-established, dividend-paying companies, with a history of rising sales, if not earnings and dividends.”
We have always viewed dividends as a sign of investment quality, and more reliable than capital gains. They can contribute up to a third of long-term investment returns.
Our appreciation of dividends has been accompanied by a detailed examination of dividend-paying stocks to determine those with the greatest potential to sustain, and raise, their payouts. It makes sense that the companies with the resources and confidence to do this are also likely to reward investors with substantial capital gains.
Over time, the key points we use to examine dividends became our Dividend Sustainability Ratings – eight factors we use to determine a company’s ability to maintain its current dividend and increase payments over time.
In the volatility that followed the recession of 2008, we have seen more investors share our high regard for dividend stocks. We recognized that our unique approach to rating dividend stocks was likely to find a receptive audience. And that proved to be true when we launched the Dividend Advisor.
As previously mentioned I’m a hybrid investor – I follow an indexing approach and I invest in dividend paying stocks for income. What is the Dividend Advisor take on indexing?
We continue to feel that a well-diversified portfolio of high-quality stocks (like those we recommend in our Dividend Advisor newsletter) will outperform index funds over the long term. But we do recommend some low-fee index funds in our Canadian Wealth Advisor newsletter.
Index funds (funds that invest so as to equal the performance of a market index, such as the S&P/TSX 60) do show better long-run performance than the majority of actively managed mutual funds. That’s partly because index fund fees are very low in comparison to actively managed funds. Still, our advice hasn’t changed: stick with well-established companies and spread your holdings out across most if not all of the five main economic sectors—Utilities, Finance, Resources, Consumer and Manufacturing. This should give you a well-balanced portfolio of stocks that tends to lose a lot less during periods where indexes fall sharply. That’s because big market slides are particularly hard on the hottest, most popular stocks of the preceding market rise, and investing as we do leads you to avoid excessive investment in the hot stocks. Index funds, by contrast, do tend to load up on the hottest, most popular stocks as they rise such as Valeant Pharmaceuticals before its big collapse in early 2016. That’s because, as they rise, these stocks make up a rising proportion of the index.
I use dividend yield, dividend payout ratio, dividend history along with other metrics to analyze and re-review my stocks. What makes Dividend Advisor valuable or unique from other newsletters?
Our Dividend Sustainability Ratings look at the underlying reasons for the ratios and other indicators that investors routinely use to evaluate dividend stocks. The eight factors that make up our ratings focus on the strengths, or weaknesses, of a dividend-paying company. Dividend history is one of the factors we use: companies are rewarded for a steady record of dividend payment and dividend increases. Yet these are the result of a company’s success. So we also look at factors fundamental to that success, such as an attractive balance sheet, a record of steady earnings and cash flow, and industry dominance.
Readers of Dividend Advisor see ratings for dividend stocks (Highest, Above Average and Average Sustainability) based on each company’s overall strength. We believe this gives the clearest possible picture of any company’s ability to continue to pay, and to increase, its dividend.
Finally, what stocks might Dividend Advisor recommend at this time and why?
Well, we have about 100 in the Dividend Advisor – spread out across several portfolios.
Here’s three of them Mark for your readers:
MCDONALD’S CORP. is the world’s largest operator of fast-food restaurants, with 36,500 outlets in 120 countries. The company raised its quarterly dividend by 5.6% with the December 2016 payment, to $0.94 a share from $0.89. The new annual rate of $3.76 yields 3.4%. McDonald’s has increased the payout each year since it began paying dividends in 1976.
The company’s new growth plan should continue to give it more cash for dividends. The strategy involves selling 4,000 company-owned outlets to franchisees. As a result, those partners will operate 95% of the chain’s restaurants by 2018, compared to today’s 81%. This will free it from maintaining and upgrading these outlets. Its TSI Dividend Sustainability Rating is Highest. TSI feels McDonald’s is a buy.
CAE INC. is a leading maker of flight simulators for commercial and military aircraft. It also operates pilot-training schools in over 30 countries, and makes mannequins and other medical-simulators for training health care professionals. Beginning with the September 2016 payment, CAE increased its quarterly dividend by 6.7%, to $0.08 a share from $0.075. The new annual rate of $0.32 yields 1.8%. Its TSI Dividend Sustainability Rating is Above Average. TSI feels CAE is a buy.
RIOCAN REAL ESTATE INVESTMENT TRUST is Canada’s largest real estate investment trust (REIT). The REIT pays monthly distributions of $0.1175 a unit, for a 5.4% annual yield. These payouts claim about 90% of the trust’s cash flow. However, 7% of its unitholders take part in its distribution reinvestment plan (DRIP), so they get units rather than cash. On that basis, about 84% of RioCan’s cash flow goes toward those cash payouts. RioCan trades at 17.4 times its forecast 2017 cash flow of $1.49 a unit. That’s reasonable in light of the REIT’s highly profitable properties and its 95.1% occupancy rate. Its TSI Dividend Sustainability Rating is Above Average. TSI feels RioCan is a buy.
Thanks for your insight about this newsletter.
All information above is current at the time of this post.
Summary and my take
Mr. Market is fickle.
He’s unpredictable when it comes to stock market behaviour in the short-term. This makes indexing an obvious choice – for many of us – because after money management fees are factored in most investors can do better by investing passively through low-cost index funds. This doesn’t mean everyone must follow this approach nor is it the only way to invest. I index invest but I also buy and hold many dividend paying stocks for income. Your mileage may vary.
If you choose to follow some form of active investing, I encourage you to:
- Be very selective in what you invest in; follow predefined criteria,
- Set an appropriate asset allocation for these investments, and
- Keep the costs to buy and hold these investments ideally as low as possible – including costs to rebalance your portfolio.
For My Own Advisor readers, TSI is offering its lowest possible discount. You can begin with one free month of TSI Dividend Advisor.
After your 30-day free trial, you can have TSI Dividend Advisor for just $68 for one full year (12 issues plus your weekly Email Hotlines). With this offer, you save $129 off the regular annual rate.
Disclaimer and disclosure: Please consult a financial professional before making any major financial decisions. TSI is a partner with My Own Advisor.
Cannew, it’s the total return that matters, regardless of whether you like to focus on dividends or capital appreciation. The point of the paper is that if you don’t own the 4% of stocks that give you that huge total return, you will underperform the market. I agree that other strategies can do very well, but they will underperform the market. That is what the data shows. Of course we are all entitled to our opinions, but when it comes to something as important as one’s financial security, I prefer to look at the evidence.
“Grant: @The above paper shows that the real risk for stock pickers is missing out on the small percentage of companies that do exceedingly well. Over the past 20 years, this would be stocks like amazon, msft, csco”
Of course your talking about missing the growth of capital or share price. For me that’s the losers game and that’s why the vast majority, chasing or seeking those few Rising Stars, end up losing money.
and for “So, if you are going to have a concentrated portfolio, a long term investor better be damn sure he owns at least some of those very few stocks that are going to be the extreme winners.”
Certainly if one chases growth, but there are other ways to pick stocks which don’t have anything to do with Finding the Winners and will do extremely well (and IMO better than any index).
Mark, I though you might be interested in this new paper on a major reason why stock picking usually underperforms indexing.
My takeaway is that indexing is not a hedge against ignorance. Rather, indexing is a hedge against the great risk of not owning the very small percentage of stocks that, over the long run, constitute the majority of the stock market’s wealth creation.
Many stock pickers see the risk of index investing as owning a bunch of crappy companies that they would never choose to invest in individually.
The above paper shows that the real risk for stock pickers is missing out on the small percentage of companies that do exceedingly well. Over the past 20 years, this would be stocks like amazon, msft, csco…
In fact, most companies do poorly; so poorly they do not match the returns on treasury bills. The market over time creates wealth because a very small percentage of companies create massive wealth, so much wealth that they compensate (and then some) for the thousands of underperforming stocks. Their massive outperformance is essentially the equity premium an investor demands over the risk free rate.
The data in that article shows that from 1926 – 2015, an incredibly long holding period, if some unlucky active investor had failed to invest in the best performing 3.8% of stocks, he would have merely equaled the performance of T bills. That’s a pretty shocking find.
Of course, on the other hand, if he had bought some stock in Altria, GM, and Exxon, he’d have mountains and mountains of wealth. That is the game. But picking those very few stocks, in advance….exceedingly difficult and explains why nearly all stock pickers underperform the index.
So, if you are going to have a concentrated portfolio, a long term investor better be damn sure he owns at least some of those very few stocks that are going to be the extreme winners.
The easiest and least risky way to do this is to own everything. The risk of owning a bunch of poor performing companies, in the long term, is easily drowned out by owning ALL of the best companies.
Thanks for sharing Grant. This is what makes indexing foolproof – less small money management fees – you are virtually guaranteed to get the return of the index you track long-term, as long as, you stay invested and control your investing behaviour.
Knowing what stocks to “stay in” and to avoid will always be a challenge but I firmly believe, rightly or wrongly, owning the top stocks in Canada held by ETF XIU directly will a) give me a return equal to XIU with b) more income than XIU can generate and ultimately c) more total return.
Everything else I largely index using VTI because I simply can’t do the same in the US. Just too many stocks.
I appreciate these articles. They make me think.
Try The Connolly Report, the ultimate site for Dividend Growth information for his regular rate of $50/year. Tom has been publishing it for for over 35 years, so he’s not a new comer to the topic.
Tom’s report is good, agreed!