Recently a reader wrote an email and asked some questions related to dividend investing. I always appreciate hearing from readers and receiving their personal finance and investing questions. Please keep them coming!
Anyway, with this reader’s email questions, I quickly replied with some simple answers. However, I thought I would elaborate a bit and turn it into a blog post. Hopefully, someone who is starting out with investing and dividend growth investing will find these answers helpful.
Question 1. Fees for building a diverse portfolio:
I very much like the idea of a diverse dividend portfolio. I dislike dividend ETFs because of the built-in management fees. If you have a 3% dividend yield and 0.5% goes to MERs, that’s 1/6 of our returns going nowhere.
The alternative is to do DIY dividend growth investing, but there are challenges as well, such as trading commissions.
To minimize commissions, it is best to make lump-sum purchases. But that leads to a longer wait time before your money can work for you, and the biggest issue is that your portfolio is not diversified compared to holding dividend ETFs. Alternatively, you can make small purchases over time but you would incur way too much in commissions. How did you work through this challenge? What was your process?
A: First of all, the distribution rate of a dividend ETF (and an index ETF) already taken account of the MER fee. So if Vanguard Canada High Dividend Yield Index ETF (VDY) has a dividend yield of 3.96% and an MER of 0.22%, the 3.96% is after subtracting the MER. Having said that, you are right about not getting as much returns, but I guess that is the price you pay for diversification.
You are also correct that you are less diversified if you purchase individual dividend paying stocks right from the beginning. If you purchase the likes of Bank of Nova Scotia, Johnson & Johnson, Proctor & Gamble, for example, you are still getting a lot of geographical diversification, because these companies are international companies. You are, however, not sector diversified. Is geographical diversification more important than sector diversification? Or the other way around? Generally speaking, I think there’s a low risk in purchasing international companies with solid fundamentals. I am not as worried about sector diversification, this is something you can build up over time.
Having said that, it makes sense to start off with some index ETFs first to create some sector diversification first. Once you have a sizable index ETFs in your portfolio, you can start purchasing individual dividend paying stocks. This is why I like having a dividend portfolio consisted of both index ETFs and individual dividend paying stocks.
Whenever we purchase individual dividend stocks, we try to keep the transaction fee below 1% of the overall cost. Since Questrade’s commission is $4.95 per trade and TD Waterhouse’s commission is $9 per trade, we usually make $1,000 purchases as a minimum (often a higher dollar amount).
Another thing to keep in mind, if you are doing a hybrid approach like us, is that Questrade offers commission-free ETF trading. So you can build up your ETF holdings over time by making small dollar amount purchases. This is something we do every other month to build up our VCN and VXC positions.
If you are planning on opening a Questrade account and want to get up to $250 of rewards, please contact me for a referral code. Alternatively, you can use my QPass Key 335712213387087 when signing up. You can receive from $25 to $250 of cash reward depending on your account size.
Question 2. Timing:
I am a believer of “time in the market is more important than timing the market”. But the bull market has been running strong for about 10 years now. The steam sure will run out at some point. Would it be a prudent strategy to hold off on buying anything, hold only cash, and start buying dividend stocks when we see a bear market? The bull run theoretically can keep going for many more years, but history isn’t on that side of the argument. If you were a newbie starting out with investing, what would you do?
A: Yes the bull market has been running strong for about 10 years now, but nobody can predict the future. On Feb 26, 2009, I purchased 100 shares of Royal Bank (RY.TO) at $26.92. I thought I had purchased the stock at an extremely discounted price. However, during that time, everyone was talking about a market double-dip (i.e. the market recover, then another big drop). Back then, I was very worried this would come true, even though Royal Bank had very strong fundamentals.
As it turned out, the Royal Bank stock recovered a bit in early March then the market took a turn in the negative direction. I panicked and sold all 100 shares at $29.05 for a small profit.
Little did I know, the stock price would eventually recover and climb higher and higher.
Today Royal Bank is around $100. If I had held on these 100 shares, I would have been looking at almost a 4 bagger!!!
What did I learn from this experience?
Pay attention to stock evaluation. As a long-term investor, it is far more important to find undervalued stocks. They will outperform fair-valued or over-valued stocks over time.
So don’t buy anything that is over-priced. Compounding long term and stay in the market do matter. Stop worrying about the market noises. Statically speaking, yes, a bear market should be around the corner, but nobody can predict the future. Nobody knows whether the bull market will continue or if a bear market will start tomorrow or not. When Donald Trump was elected the president of the United States, some analysts thought we would see a market crash and the start of a bear market. Look where we are today, the Dow Jones Industrial Average was around 18,000 points at the end of 2016 now it is around 25,000 points; the TSX Composite Index was around 14,000 at the end of 2016 and now it is around 16,000 points.
Another thing to mention is when I started to purchase individual stocks around early 2007, I purchased ING (now called Intact Financial) and Manulife Financial. I made both of these purchases before the financial crisis. The stock price for both dropped significantly during the crisis. But I decided to hold on to them and collect dividends. I ended up adding more Manulife shares to dollar cost average my purchase price. Now 10 years after the financial crisis, we are looking at a sizable gain for both holdings.
Personally, I think it is far better to stay in the market and let your money work hard for you rather than stay out of the market and hide your money under your mattress and hope your money will grow (unlikely, unless you are talking about molds growing if the bills get wet. Good thing that the Canadian bills are all plastic now, but that’s another story for another time…). If you are truly worried about the impending bear market, I would have a high cash allocation, say 30-40%, so you can buy stocks when there’s a good opportunity. For example, if the stock market drops by 20% in a few days, having some cash on hand will allow you to purchase stocks at a discounted price.
Mr. Tako Escapes recently wrote a great article where he compared river rafting to investing. The destination is financial independence and the river itself is the investment market that you traverse. The rafts that you ride through the river are the assets you can invest in. Getting into or out of a raft equates to buying or selling of an investment. I really love this analogy. If you haven’t read this article yet, I highly recommend it as it relates very well to this timing question.
Question 3. Chasing yield:
I totally admit that I am enamoured by high yield and am very tempted to buy them, like Enbridge and Laurentian Bank. Yes, if the stock price tanks, it makes no difference (as you mentioned in one of your posts). But how is that any different than if you buy into the market now and it tanks? If you take a look at the list of Canadian dividend aristocrats today, how would you go about picking your first 5 dividend stocks?
A: Funny that you mentioned Enbridge and Laurentian Bank. We actually purchased quite a bit of Enbridge earlier this year when the stock price was around the 52-week low. The price has actually recovered quite a bit since (nice for us). We also initiated a position in Laurentian Bank earlier this year and purchased more shares recently. Laurentian Bank’s price, unfortunately, has not recovered yet. I believe both of these companies have solid fundamentals. People will continue using oil and natural gas for many years to come, and Enbridge’s pipelines will be utilized for transporting oil and natural gas. Canadians will continue banking with Laurentian Bank and use their financial products. The higher than usual dividend yield for these stocks was due to the temporary price downturn and the headwinds that they are facing. Since both companies have a healthy payout ratio, they should be able to continue paying out dividends and possibly raise the dividends.
On the other hand, Corus Entertainment has a very high dividend yield. The business is deteriorating as more and more people are cutting cables and subscribing for streaming services. Although Corus Entertainment had recently cut its dividends, the payout ratio still appears to be extremely unhealthy. It would have been a better move if the company suspends the dividend payments and look at improving its business. Buying Corus Entertainment for dividend yield alone is simply not a good idea.
In terms of picking out first 5 dividend stocks, I have actually written a couple of guides before.
So take a look at them to help you decide on the first 5 dividend stocks to purchase.
Dear readers, if you have any questions, feel free to contact me.