What is Dividend Investing? Why Should You Do It?
The following is a guest post written by Mike from The Dividend Guy Blog and Dividend Stock Analysis. Mike has a MBA in financial services and writes about dividend investing since 2010. His goal is to use dividend growth power to retire early.
Mark (My Own Advisor) and I have been blogging friends for a long time. One thing we have in common is definitely our strong belief in dividend investing. When people hear the words “dividend investing” some think that we are talking about stocks paying 5% or 6% or 7% dividend. If you have been around for a while you’ve probably even benefited from the “black gold rush” with Albertan oil income trusts paying double digit dividends. If you want to become a successful investor, the first thing you should do is to ignore high dividend yield securities and concentrate on quality dividend stocks.
What is So Great about Dividend Investing?
Among all the investing strategies you can use, dividend investing is probably the one which can assure you the best results when you consider the time required. You don’t have to believe me; you just have to believe the past 85 years on the stock market:
Image source: JP Morgan Asset Management
Over that long period, 43% of the total S&P 500 return has come from dividend payouts. If you look closely at the chart, you will also notice that the S&P 500 shows 2 negative decades; the 1930s and more recently, the 2000s. In the 1930s the dividend investor could have offset his/her losses completely (-5.3%) by his dividend payouts (+5.4%). In the 2000s the impact was not enough to completely offset the losses but someone who has only dividend stocks in their portfolio certainly had a dividend yield paying more than 2.7% to offset the capital losses.
Since most of us invest for our retirement and not just today, being able to protect our capital is crucial, especially when you start withdrawing funds from your nest egg.
Index Investing vs. Dividend Investing
After the mutual fund revolution, we witnessed a new phenomenon during the 2000s; the ETF revolution. Inspired by Vanguard’s success, several investing firms now offer Exchange Traded Funds (ETFs) following any index you can think of. Since 95% of mutual funds don’t beat their referring index over 5 years, why would you bother paying high management fees when you can buy the index for less than 0.25% MERs?
If I’m almost 100% certain of making the index return with a very small fee, why would I start managing my own stocks and build a dividend portfolio? The answer lies in the control of volatility.
Historically, dividend stocks have been less volatile than the overall index. That totally makes sense since most investors seek stable sources of income during recessions. Since dividends are rarely cut by strong companies, it is one of the favourite investment approaches during a crisis.
If you compare “popular” dividend stocks to the S&P 500 during the worst investing year ever (2008), you get the following results:
S&P 500: -40.98%
MCD: +2.62%
JNJ: -13.08%
CVX: -25.83%
KO: -28.41%
As you can see, the four blue-chip stocks I’ve chosen above beat the index by far. Index investing believers are probably going to tell me that the S&P 500 jumped higher in 2009 than those stocks, right? Well, let’s look at the graph from January 2008 until December 2009 to see if the S&P 500 did better than those four stocks:
S&P500: -25.42%
MCD: +4.49%
JNJ: -4.46%
CVX: -18.92%
KO: -28.62%
Coca-Cola is the only stock that under performed the index in this example. However, if you take the four stocks as a portfolio you’re way ahead the S&P 500 and I’m not even counting their dividends!
The Reason I Chose Dividend Investing
I chose dividend investing is because I wanted to count on stocks paying me more each year. When you select dividend growth stocks, you can expect to see your dividend payouts being increased year after year accelerating your wealth. It’s a great way to protect your money against inflation and to generate passive income month after month, quarter after quarter and year after year 😉
Do you pick only dividend stocks? What is the best investing strategy for you?
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Wow that was odd. I just wrote an incredibly long comment
but after I clicked submit my comment didn’t show up. Grrrr… well I’m not writing all that over
again. Anyway, just wanted to say great blog!
I think that what lies ahead of us will be either like in 90s or small dividends and small capital growth.
One of the main reason is inflation. All these cheap mney pumped into the economy should unleash a merry hell inflation wise.
I think the table is not necessarily representative – there is few to no companies which can demonstrate both – dividends & capital appreciation.
As these are two parallel Chanel where generate cash flow could be route – paying out or reinvesting.
I can see small capital growth going forward. This is also a reason why I invest in dividend paying stocks, a diverse bunch of them. In good times and in bad market times, I get paid.
Inflation should be a mess in another few years down the road. I wouldn’t want a fat mortgage in another 10 years…it’s going to get ugly.
Thoughts?
@My Own Advisor
Thanks for the great feedback!
Yes, I plan to stick to Canadian ETFs for the time being. I will definitely be investing in some dividend ETFs for income and diversification.
My short term goal(1-2 years) is to generate 4 figure income off my TFSA in a year and then go from there. I would love to hit 5 figures someday just like you. However, I understand the time, patience and diligence that needs to be taken to achieve this.
Also, for my RRSPs I’m sticking with the e-series for now as I don’t quite have the $50k most people say you need to start buying ETFs. I know you have an article saying that $25k should be enough to start but I decided to wet my feet first with TFSA and maybe next year move into ETFs.
Thanks again. I will be glued to your blog from now on.
Cheers
You’re welcome. Drop me an email if you have more questions via my Contact page.
Your plan to stick to Canadian ETFs, low cost ones, is a good one I think. Sprinkle in a few a dividend ETFs for income and diversification and pick the rest that are as broad-based and low-cost as possible.
A 4-figure TFSA income would be a very good start.
I should be a 5-figures dividend income in another 2 years but you never know with life. We’ll see. Let’s hope anyhow.
Thanks for supporting the blog, I look forward to more comments.
Hi MOA,
I just discovered your blog and so far love the articles. Very informative.
I had a question though regarding investing. Currently, I’m invested in the couch potato method with the TD e-series funds for my RRSP. My TFSA is stuck in a lowly interest account. I’m in the process of moving it over to a TD waterhouse account and investing in the Vanguard ETFs. I was wondering what do you think is better for generating income: ETFs or dividends or a combination of both? I’m kinda new to this and have been reading quite a bit in the last month or so apologies if I dont quite understand the strategy in your article. Btw, my TFSA is maxed out at $25,500.
Thanks!
Hey Alex!
Glad you found the blog…tell others 🙂
TD e-series are great for the Couch Potato. I’m sure you know that by now.
Nothing wrong with the TFSA in an interest account, as long as you understand why you have the money there. We had our money there for years, while saving up for a house. Now that we have the house we want, we use our TFSAs for retirement accounts – at least they will be in 10+ years.
Back to you….Vanguard ETFs are great, as long as they are Canadian Vanguard ones, but I wouldn’t hold the US Vanguard ETFs in your TFSA since you’ll be charged withholding taxes. That’s just me:
https://www.myownadvisor.ca/indexing/
Personally, I’m a fan of holding the stocks directly for income. You read more here:
https://www.myownadvisor.ca/2013/02/january-2013-dividend-income-update/
Dividend ETFs are great but you need to invest in what you are comfortable with. Otherwise, you’ll be worrying all the time and that isn’t investing. Many dividend ETFs are great for income. Some good ones are XDV, CDZ and ZDV. You can find links to those, as some of my favourites here:
https://www.myownadvisor.ca/indexing/
Drop back in and let me know if you have more questions, or simply use my Contact page.
Cheers,
Mark
Great post Mike!!! I especially liked the “Index Investing vs. Dividend Investing” section.
I have found in my experience that the more stocks you own the lower your return is going to be, in fact your return will start to resemble the stock market (index) return. I’m more than happy to own my basket of around 20 dividend paying stocks than to own an index fund with hundreds of stocks in it’s portfolio.
It was a good post eh?
Thanks again to Mike for the article.
Kanwal, I think a basket of 20 stocks is great, all blue-chips. That’s my plan as well….well, holding about 40 eventually; about 30 from Canada and up to 10 from U.S. Everything else will be indexed.
Once all holdings can DRIP, synthetically, including the ETFs, my retirement plan will be on autopilot! About 5 years of investing away from that happening.
@Moneycone
I’m considering adding a ETF to my portfolio in order to add instant diversification. Plus I think it’s a great way to benefit from the “pure growth” stocks when dividend stocks are less trendy (who knows what will happen after the fiscal cliff!)
Sounds like a good call to me! I currently own a few stocks and ETFs for the same reason.
@Rob
Adding a few US stocks would help you diversify your portfolio. Maybe you can copycat your model to find US stocks as well?
On top of that, I’m betting on a drop of the Canadian dollar so it’s the right time to invest in US dollars 😉
Loving the high CDN dollar for US investments now.
I don’t invest in ETFs or Index Funds yet. Slowly getting there, but I’m learning a lot along the way from vets like yourself. Great post.
Thanks for the kind words Eddie. Dividend stocks and low-cost ETFs definitely work in my portfolio!
What are you currently invested in BTW?
I’m a fan of dividend investing AND indexed investing. Those are good examples, but too selective. For example, if you put in Gold for the same period, it would show that it performed better than all the other stocks! Not shilling for gold, but using it as an example.
The point of indexing is not earth shattering performance, but mitigating risks. Even the best run companies can fade into oblivion, an index will live on.
I am a huge fan of Dividend Growth Investing, because I love the idea of creating passive income streams. When my passive income streams match my expenses, I’ve achieved financial independence.
At this point, I am about 80% invested in dividend growth stocks, 10% invested in high yield dividend paying companies (MLPs, BDCs, REITs), and 10% in cash secured puts. My 401k is just a low fee SP500 index fund.
I am looking into other income producing assets as well, but I’m not sure when or if I’ll move into them.