Lately, I have been getting a few emails from readers with dividend growth investing and index ETF investing questions. I thought I had answered quite a few questions in the Dividend FAQ page, but I guess not.
So, I decided to summarize the questions and answer them today.
Q1. What is the dollar value of your portfolio?
First of all, we don’t disclose our portfolio value and how many shares we own for each stock and index ETF for privacy reasons. I am not blogging anonymously anymore so I have to keep privacy in mind and determine what I share on here.
Having said that, it shouldn’t take a rocket scientist to guess roughly how much our portfolio is. All you need is MATH!
(This is why you should pay attention in math classes!)
Take 2018 for example, we received $18,734.29:
- At 2% dividend yield that means our portfolio value would be $936,714.50 ($18,734.29 divided by 0.02).
- At 3% dividend yield that means our portfolio value would be $623,476.33 ($18,734.29 divided by 0.03).
- At 4% dividend yield that means our portfolio value would be $468,375.25 ($18,734.29 divided by 0.04).
- At 5% dividend yield that means our portfolio value would be $374,685.80. ($18,734.29 divided by 0.05)
See how easy that is?
So, our portfolio value is anywhere between $374,685.80 and $936,714.50 at the end of 2018. You can take a wild guess of the actual portfolio value.
Q2. How do you know how many shares to purchase?
Before I answer the question, let’s get into a bit of a history lesson. Some of you may have heard of the term “lot.” A lot is the standard number of shares in trading security. Many moons ago, the standard minimum stock order that could be placed through an exchange without incurring higher commission fees was 100 (or a round lot). That means you’d only trade a number of shares that can be evenly divided by 100 (i.e. 200, 500, 1000, etc). An “odd lot” refers to a number of shares that can’t be evenly divided by 100 and this would trigger higher commission fees.
However, thanks to online trading platforms, you no longer have to pay a premium for trading in odd lots. You can now easily buy as little as one share, or with some brokers, fractions of a share. Technological advancements have been a good thing for individual traders like us!
Now the history lesson is over – the general rule of thumb I have is to purchase enough shares so that the commission fee is less than 1% of the overall transaction cost. Since Questrade’s commission is $4.95 that means I only trade with $495 or more. And since TD Waterhouse’s commission is $9.99, that means I only trade with $999 or more. Having said that, trades I made in the last number of years are usually higher than $1,000. With the total transaction cost in mind, I then work backwards to figure out how many shares to purchase.
For example, say I have $1,500 on hand, the stock price is $43, and the trading commission is $4.95 (for simplicity’s sake, I’ll ignore the ask/bid price and limit orders); this means I can purchase 34 shares ((1500-4.95)/43).
Q3. What percentage of money should be allocated to different stocks?
This is a tough question to answer as this would be a personal preference and the total percentage allocated to each stock would greatly depend on the size of your portfolio.
For example, I can purchase $2,000 worth of BNS shares which make up a small fraction of our total portfolio. But if your portfolio size is $10,000, an additional $2k in a specific stock would make up 16.7% of your portfolio.
That’s why I recommend starting out with index ETFs so you get instant diversification. Once you have a sizable portfolio in index ETFs, you can start buying individual dividend stocks if you choose to.
Basically, don’t be like me… when I started investing, I purchased 100 shares of Intact Financial and owned nothing else. That meant I had 100% in one stock. Later, I purchased 100 shares of Manulife, so I finally had some “diversification”. I was young and didn’t know much about investing and diversification. I also didn’t need the money for the next 5 years, so I was OK with the higher risks. Plus, index ETFs weren’t as popular back then and I hadn’t even heard of index ETF investing at that time. The choice was between mutual funds or individual stocks. I went with the individual stocks route and never looked back (note, I did own some mutual funds at the time).
Back to the original question – what percentage of money should be allocated to each stock? Well, I believe you shouldn’t hold more than 5% of your portfolio in an individual stock for diversification reasons. For equity index ETFs, I believe holding up to 50% in one index ETF is OK.
Q4. What are eligible dividends and non-eligible dividends?
The key difference between eligible dividends and non-eligible (or ordinary) dividends is how you get taxed if you receive dividends in a taxable account.
Essentially, eligible dividends get more favourable dividend tax credit while non-eligible dividends do not.
Why is that? Well, eligible dividends are paid from a corporation’s after-tax profits. This means the corporation has already paid corporate income tax on that income. To avoid “double tax,” the Canadian government allows you to get a 38% dividend gross-up rate which leads to a higher tax credit rate. The net result is that eligible dividends will have a lower marginal tax rate than the marginal tax rate for employment income and interests.
On the other hand, for non-eligible dividends, you only get a 15% gross-up rate. Because of the lower gross-up rate, you don’t get as much tax credits compared to eligible dividends.
If you want to look at the actual numbers and the different tax brackets, you can find more information below:
- Federal & Provincial/Territorial Enhanced Dividend Tax Credit Rates
- Federal & Provincial/Territorial Non-Eligible Business Dividend Tax Credit Rates
Q5. What do you do when you max out RRSP and TFSA?
If you can max out RRSP and TFSA each year and have leftover money to invest, that’s a very good problem to have!
If you have leftover money to invest after maxing out RRSP and TFSA, I assume you want to be as tax efficient and simple as possible. I will also assume that you have no debt. If you do have debt, whether it’s mortgage or consumer debt, I think it makes a lot of sense to pay down these before you consider investing outside of RRSP and TFSA. If you have kids, another option is to contribute to their RESPs with the extra money.
If you don’t have any debt and have already maxed out RESP, consider yourself very fortunate. In this case, the only place to invest the extra money is in a non-registered or taxable account.
Since taxable accounts are subject to income tax (hence for the name “taxable”, ha!), you want to be as tax efficient as possible. Since bonds, GICs, and international dividends are taxed at 100% of your marginal rate, this means it’s best to invest in Canadian equities inside of your taxable account.
Where does that leave you? One option is to invest in an index fund that tracks the Canadian market. Vanguard Canada All Cap Index ETF (VCN) and iShares Core S&P/TSX Capped Composite Index ETF (XIC) are good options due to their low fees.
The other option is to invest in individual Canadian stocks. You can either purchase a Canadian stock that doesn’t pay any dividends or a stock that pays dividends. If you go with the dividend paying stock route, make sure that you purchase a Canadian stock that pays eligible dividends for reasons stated above.
Q6. What are some key metrics that you use when it comes to deciding whether to purchase a stock or not?
For the most part, I follow a similar scorecard approach as outlined here. Some key metrics I like to examine in a stock include the following: PE ratio, PEG ratio, return on equity, payout ratio, and 5 years and 10 years annualized dividend growth rate. I also like to take a look at the PE and payout ratio history trends to see how the company is doing compared to historical averages. If I’m investing in a new company, I would typically take a look at the company’s annual and quarterly reports to dive deep into their numbers. I want to learn as much about the company as possible before investing money with them.
Q7. Why are you investing in both dividend growth stocks and index ETFs?
Because I see the benefits of dividend growth investment and index ETF investment. We want the best of both. We want the predictable income from dividend stocks and the instant diversification and tracking market performance, minus fees from index ETFs. I also like the idea of constructing our own portfolio and being more hands on.
Q8. How do you buy stocks and ETFs?
First of all, you need to have an account with a discount broker. If you bank with one of the big five banks, they have an investment arm within the company. So the easiest way is to set up an account with your bank (i.e. TD is TD Waterhouse, Royal Bank is RBC Direct Investing, Bank of Nova Scotia is Scotia iTrade).
When it comes to accounts, you can open registered or non-registered accounts. By registered I mean, RRSP, TFSA, and RESP (we’ll ignore RRIF for now). By non-registered, I mean your regular taxable accounts.
If you’re new to investing, when you open an account, it’s best to not sign up for “options trading”. This will keep things simpler.
In case you are wondering, we use Questrade and TD Waterhouse as our discount brokers. I highly recommend Questrade, because the trading low commission of $4.99 and free commission when buying ETFs. If you want a referral code for Questrade, please contact me. Alternatively, you can use my QPass Key 335712213387087 when signing up to get a referral bonus.
Q9. What is the average you are using for your dividend rate?
I used to use 3% average for dividend rate but lately you probably noticed that I have been using 4% average for dividend rate. I think using 5% average dividend yield is too high and you may end up chasing higher yield stocks because of that. Chasing for higher yields, in term, can create more risk for you.
Why use 4% rather than 3%? If you look at the 12-month trailing yields for Vanguard Canada All Cap Index ETF (VCN), iShares Core S&P/TSX Capped Composite Index ETF (XIC), and Vanguard Canadian High Dividend Yield Index ETF (VDY), they are 2.52%, 2.83%, and 4.04%. VCN and XIC include many stocks that do not pay out dividends, hence it makes sense that these ETFs have a lower yield. VDY only holds Canadian dividend stocks and while the individual stock weighting is different from our dividend portfolio, it gives a rough indication of what average dividend rate we should use.
Another reason of using 4% dividend rate is that it matches up nicely with the 4% withdrawal rule, and when you divide by 4%, the math is cleaner than dividing by 3% (i.e. if you divide by 3%, you often end up with a repeating pattern).
Q10. Do you compare your dividend portfolio to a benchmark, for example, VDY or VCN? How does it perform with respect to growth?
I do compare our portfolio to both VDY and VCN and for the most part, we are doing quite well. I just haven’t disclosed that information on this blog for privacy reasons. In case you’re wondering, I don’t believe in simply buying dividend index ETFs like VDY for these reasons outlined previously.
I have been getting the same questions lately and I hope I have covered all of them. In case you are looking for more information, here are some more tips I have written in the past.
Do you have any more questions that I haven’t covered? If so, feel free to leave a comment below or contact me.