When to Avoid Dividends

The Fruits of Investing!

For a dividend investor, the answer is we never want to avoid dividends, right?
After the last post on Canadian-listed American dividend ETFs, I thought I’d provide an alternative view to one that might have suggested dividend-growth investing is the way to go.

Dividend-growth investing is very popular. I’m a fan myself. Primarily because it is a strategy that can work reasonably well for an investor with limited skills & ability to assess the potential of a stock to provide good returns. Using fewer & simpler metrics than it takes to properly evaluate a stock, it’s possible for a DIY investor to choose a portfolio of dividend-growth stocks that can perform reasonably well. And, being focused on a growing income stream, rather than on a falling share price, can help some of us ride out market downturns. The other great attraction of dividends is that as a portfolio grows, the income stream can grow &, one day, it may even match the income stream from our day job.
How cool would it be to have a portfolio that generates enough income to match your paycheque? Very cool, eh!
A retiree with a portfolio that provides a 4% yield on retirement day, might look forward to never having to sell shares. Selling shares for income can be a traumatic challenge for some retirees. And if the income stream continues to grow more than inflation, our retirees golden years might truly be golden. There’s a lot of good to be said about a portfolio of dividend-growth stocks.

But, in the world of investing, things are never simple!

Picking the right dividend-growth stocks still takes a lot of work. And it takes additional work to monitor & maintain a portfolio of individual stocks. Dividend-growth may still be a valid strategy for some. But it’s worth back-testing your stock portfolio against a dividend-growth ETF portfolio every now & then. Just to see if all the extra work produced enough extra reward. Of course the yield from such ETFs often don’t match that of a portfolio of hand-picked dividend-growth stocks. We like our bigger dividends, eh!
However, things can be different before & after retirement. And that raises some questions.

How many years ahead of retirement should we start building our dividend income stream?
Does it make sense to start early & just let the DRIP work for us ahead of retirement day?
Is it important for that income stream to grow before we retire?
But the really big question is this: should we even be focused on an income stream ahead of retirement?

Let’s take a look …

All our investors above put 100k into an ETF at the start of 2016, with a view to retiring at the end of January, 2023.
Ann & Bella are oblivious to dividends. They both followed the market index investing philosophy & went with S&P 500 Index® funds for part of their US allocation.
Ann chose Horizon’s HXS. This is a total return strategy that doesn’t pay any distribution. Unlike all the other ETFs, this one reinvests the value of the dividends inside the ETF. The income stream is zero.
Bella went with Vanguard’s VFV index fund. In this, & all other cases, distributions were automatically reinvested (the DRIP) at no extra cost.
Cathy likes the dividend-growth approach & invested in Vanguard’s VGG. She realised she might sacrifice some of the total return potential of the market, but she felt her choice was less volatile (it is, look at the Worst Year & Max DD columns) & that allowed her to sleep a little better.
Dianne was lured by the higher dividend payout of BMO’s ZDY. This ETF has a pretty good history of share price appreciation & a decent dividend growth trend. She liked that.
Emma wasn’t sure if she was into the whole FIRE thing yet but she thought that BMO’s ZWH might give her that option sooner. The juicy 6% yield from this ETF might make earlier retirement a reality for her. And the covered call strategy might offer some downside protection to boot. The Max DD is a little scary, but the worst year performance is the best of the bunch over this time period. Getting a good night’s sleep was important for Emma too.
Fiona went with a more traditional dividend approach, going with the Blackrock’s iShares® XHU offering. This is an ETF that focuses on a basket of solid, reliable, higher yielding companies in the US. A good choice for an investor who favours this approach.

Looking at the Final Balance column, I’d be pretty happy if I’d thrown a few bucks into any of these ETFs back in 2016. But what is the point of this comparison?

It’s this …

Come retirement day, we will look at things differently.
It’s not how much income was received & reinvested along the way.
It’s not how much the income stream grew prior to retirement.
It’s not about when we started to build an income stream.
It’s going to be all about the value of the portfolio on retirement day.
And how big an income stream that portfolio can buy to support our needs from that day forward.

Look at the Income column, the last one on the right. This is the income stream that would result from all the ETFs being sold off on retirement day to buy ZWH, the highest yielding ETF. The biggest income stream can be had by selling the portfolio that gave the best total return. And then buying the ETF with the greatest distribution, in this case ZWH. There is a 30% spread here, that’s significant.
Notice that in most cases, the higher yielding funds tend to have lower total return over time. That might not always be the case & it might not be the case going forward. Not even amongst this batch of ETFs. Doing your own due diligence, as always, is important.

But, from a pure numbers perspective, it matters less what happens with dividends during the accumulation years. It only matters that the portfolio grows. As much as possible. The bigger the portfolio, the bigger an income stream it can buy on retirement day. In this example, how much the income stream grew during accumulation didn’t matter. Having a bigger yield on cost didn’t matter. The only thing that mattered was that a bigger portfolio bought a bigger income stream on retirement day. For simplicity & to maximise return, all investments were considered to be inside a tax-sheltered account. There are other implications, not covered here, for selecting ETFs like this in a non-sheltered account.

Emotionally & numerically, there are many reasons that investors choose to invest differently. Seeking solutions with lower volatility, the reassurance of a growing income stream, avoiding the need to sell shares, & so on, all factor in to individual choices. All these are all important considerations, for sure. But the message here is not that we all need to abandon our chosen strategy in favour of some other promoted strategy. It’s more about giving some thought to strategies that differ from our current path. Despite the reassurances we get from like-minded investors in our favourite social media groups, it can be useful to think differently about things from time to time. We shouldn’t fall in love with one particular strategy & block out all information that conflicts with that. It might be worth taking some time to learn about different perspectives & different strategies. Keep an open mind.

By the way, I’m not suggesting that you buy any of the ETFs here. Nor am I suggesting that everything gets dumped on retirement day for one high-yielding ETF. This is just an example to illustrate why we might want to think differently about our approach from time to time. It’s just as a valid to consider switching to a basket of individual, higher-yielding, dividend-growth stocks on retirement day, for example. Or sticking the proceeds into a portfolio of your favourite high-yield funds. Do whatever floats your boat for an income stream. Believe it or not, some will stick with the growth solution that got them there & sell shares for income. But regardless of approach you choose during the accumulation years, whatever you choose to do in retirement will probably work better with a bigger portfolio. 😜

So how do you accumulate?

Important – this is not investing, tax or legal advice, it is for entertainment & educational purposes only. Opinion are my own, do your own due diligence & seek professional advice before investing your money.

When Stock Charts Lie

Picking Winners from Stock Charts? Don’t do that!

I’m not a very sophisticated investor. When it comes to choosing between two stocks or ETFs, I like to look at pictures. Let me use a couple of funds from one of my favourite fund companies, Vanguard, by way of example. Look at the chart below, which fund would you choose?
Seems like a no-brainer, it’s the blue one all the way, eh? Over the course of 9 years or so, Fund A has outperformed Fund B. Fund B managed to turn 100k into about 250k. But Fund A turned that same 100k into almost 300k. All these charts are with dividends reinvested.

Let’s look at one more, this time from another of my favourite fund companies, BMO Global Asset Management. Similar story here, Fund X is crushing Fund Y. While Fund Y turned 100k into more than 250k, Fund X managed to return over 325k during that same time. Another no-brainer choice, eh?

No, it’s not quite as simple as that.
In fact, the ETFs used in each of these charts are, for all intents & purposes, identical.
So why are the charts suggesting otherwise?

The difference mainly comes from the currency of purchase & the differences in exchange rates over time.
Fund B in the Vanguard chart is VIG, an American-listed dividend appreciation fund & Fund A is a Canadian-list fund, VGG, which only holds … wait for it … VIG, the exact fund that plotted the chart for Fund B. VIG is purchased in US dollars, while VGG is purchased in Canadian dollars.
Fund X is BMO’s Low Volatility US Equity ETF, ticker ZLU, listed on the Canadian exchange. While Fund Y is the US dollar version of exactly the same fund, ticker ZLU-U, also listed on the Canadian exchange. Yes, you can buy funds on the Canadian exchange in US dollars. The apparent outperformance of the funds listed in Canadian dollars is due to the general decline of the value of Canadian dollar against the greenback over those years. The value of the companies in both funds is identical but the numerical value in US or Canadian dollars changes with changes in the currency exchange rate. Back in 2013 you could swap a loonie for about 97 cents American. Today, it’s about 74 cents. That makes for a bigger number in Canadian dollars at the end of the chart. But the relative value is far closer than the charts suggest. If you were cashing in your portfolio to buy a condo in Florida today, your loonies would be exchanged for fewer US dollars than in 2013. Nobody can predict the future of the exchange rate any better than the direction of the stock market but there’s another way to think about it. When the Canadian dollar is strong, Canadians love to go cross-border shopping. Same thing with buying American equities! 😜

So, if you need this kind of market exposure in your portfolio, which funds should you buy?

Simple question but there are a lot of things going on here so the answer is not so simple. The American VIG comes with a 0.06% fee, while the Canadian version charges 0.30%. The Canadian fee is 5 times larger. Though it still looks small, small fees can make a difference over time. The BMO funds both have an MER of 0.33%, so that’s a wash. As Canadians, we’re used to paying more than our American cousins for a lot of things &, unfortunately, that includes fund fees. So why not buy the American-listed fund instead? Again, not so simple. Doing that involves currency exchange fees. Along with the potential for additional tax reporting & liability concerns, of particular concern with larger holdings. To top it off, there are foreign withholding taxes to consider. These can be protected by collecting dividends from American-listed equities inside an RRSP or RRIF, they can be offset in a taxable account, but they are not recoverable in a TFSA. Nor within any tax-sheltered account if the American dividends are coming from a Canadian-listed ETF holding American dividend paying companies. These are all topics for another day but the message for today is this … don’t make your investing decisions based on a random chart you see online. And especially not on the charts above. It’s just not that simple.

Now, you shouldn’t let this paralyse you either. If you’re just starting out, there is nothing wrong with sticking with the path of least resistance. There are no guarantees it will be the same going forward but if past market performance is anything to go by, having an allocation to Canadian-listed Canadian-dollar funds that track an American index should serve you well. If you are saving & investing small amounts regularly, & if you expect to be doing that for many years, you can dollar-cost-average your way through the fluctuations of the currency exchange rate, in addition to those of the market. It’s usually not wise to wait for the “right” currency exchange rate. A lot of market growth potential can be missed while waiting for the right time to invest. If you happen to get a bonus cheque that you want to invest in US equities right when the Canadian dollar is at par, that’s great. Nothing wrong with a bit of luck either! There are other reasons why we might prefer to hold a position in US-listed or US-denominated equities but, in general, any of these funds might work for a part of the US market exposure in a portfolio.
As your portfolio grows, you will almost certainly need some professional advice down the road. Especially when it comes to taxes.

Let me modify the title a bit here: the charts are not purveying lies but they can be deceptive. Do not rely on simple charts to tell the whole story. Charts are more like a good mystery novel. There are so many nuances that you need to dig deeper in order to figure out the plot before you get to the end. And even when you do that, you should always try to prepare for a surprise ending!

Important – this is not investing, tax or legal advice, it is for entertainment & educational purposes only. Opinion are my own, do your own due diligence & seek professional advice before investing your money. Sometimes, I get stuff wrong! Please let me know if you spot any errors, of commission or omission, along the way.

Investing Ignorance is Bliss but …

It may be expensive.

In Café Veritas!

I chatted with another older (we’re not really that old yet!) guy at my local coffee shop this morning. My coffee shop is great for that kind of thing. There’re always a couple of people within earshot that are happy to chat while we sip our morning brew. And I like to chat!

Anyhow, the conversation shifted from Christmas shopping to the state of the economy & the gloomy expectations for a recession in the new year. That led to us talking about how our portfolios were performing this year. I knew how my portfolio was performing year to date, to two places of decimal. He, on the other hand, had absolutely no idea how his portfolio was doing. He thinks he’ll get something in the mail in the new year, but his advisor told him he was doing okay when they last spoke. Since I’m tinkering with the allocations in my own portfolio, I was curious about what his advisor was recommending. My coffee buddy didn’t know. When I asked about what he was invested in, he told me it was with a professional & he really didn’t know exactly what it was in. Was it stocks, bonds, ETFs, or mutual funds? He was almost sure, maybe, that it was mutual funds. But he’s been with this guy for years. He trusts him. He’s a really nice guy. And he does great things for him. Besides, my coffee companion knows nothing about all this investing stuff. Nor does he have any idea how much he is paying for the service.

While I have no idea if he was being frank with me, if that’s the true level of his understanding, it’s a potential exposure to paying more & getting less. It’s totally okay to invest with the help of an advisor, they can bring value in all sorts of ways. But you shouldn’t do it blindfolded. The difference between a portfolio fee of 0.2% & 2.2% sounds small, it’s only 2% after all, but it can be huge over time. Given the historical market returns of about 10%, a kid with $50k invested by age 30 could see their portfolio grow to a value of about $1.6 million by age 65. Without any additional saving. Drop that rate of return to 8% because of fees every year & the portfolio would be worth about $800k at retirement. That 2% reduction means that a full 50% of the potential return goes towards fees.
A retiree planning to live by the 4% rule has to make up an additional 2% to cover fees like that.
Fees matter.
Of course, if the advisor is outperforming by at least as much as the fees being charged, that’s great. That could be exceptional value. But if not, the fees might be a potentially significant overhead.

I was just there for a coffee, so I didn’t get into it any further. I don’t want to be the guy that nobody wants to talk to in the coffee shop!

When you get your annual statement this year, slow down & look at it. Compare your asset allocations to some of the ETFs that are available on the market today. Chances are pretty good that you’ll find an ETF that matches the asset allocation in your managed portfolio. The traditional 60:40 split between stocks & bonds is replicated by all the big providers in Canada, for example. BMO has ZBAL, iShares offers XBAL & the Vanguard one is VBAL. For fees around 0.2%, these ETFs might compare very favourably against a mutual fund that does the same thing. But charges a significantly larger fee of 2%, possibly more. Or compared to an advisor that is charging 2% to put a similar portfolio together for you.

Look I’m not for a minute suggesting that you drop your advisor. Advisors bring all sorts of good things to the party too. They can structure a portfolio to minimize taxes, help with decumulation strategies, provide guidance when the markets crash, & so on. But you should learn enough to have a discussion with your advisor on the cost & value of having the advisor manage your portfolio. Performance and fees are important. They should both be part of the conversation during your annual portfolio review. Who knows, you might even be offered a discount on the fees being charged. And even if you don’t, you’ll at least have an improved understanding of the cost & value of the advice you are paying for.

Knowledge is always useful. Even when it undermines the sense of bliss a little.

Important – this is not investing, tax or legal advice, it is for entertainment & educational purposes only. Do your own due diligence & seek professional advice before investing your money

Funny Numbers – The Rule of 72

The Rule of 72

After looking at the magic of compound growth in the last post, the Rule of 72 is another easy way to figure out what compounding does. Back in the 1400s, an Italian friar, Luca Pacioli, came up with this neat little rule.

Here’s how it works …

Divide 72 by the rate of return percentage on your investment to find out how many years it will take for your money to double. If you have an annual rate of return of 10%, divide 72 by 10 & your money will double in 7.2 years. A return of 3% means it’ll take 24 years for the double. One percent means it’ll take 72 years & so on. It’s not as accurate as a proper compound growth calculator, & it’s not accurate at extremes. But it’s close enough for quick mental math while you’re chatting about your amazing portfolio performance with your buddies over a latte. Of course, like many things in the investing world, there is opportunity for it to mislead us.

You could use the historical average rate of return of the American stock market to calculate what you might earn going forward, for example. That historical 10% rate of return may, or may not, continue into the future. But hoping that an index fund will double our money, on average, every 7.2 years is not a bad assumption to justify going into a low-cost index-tracking fund. Especially for anyone with a very long time to go before retirement. There are other funds out there with big yields. Many of them exceed that 10% market return rate. Wow! A 10 or 15% yield and the potential for capital appreciation, are you kidding me? The funds aren’t but, sometimes, we kid ourselves. A 15% distribution may come with a declining share value over time, for example. You can’t automatically assume that the 15% yield number will double your money every 4.8 years (72 divided by 15), forever. If it did, we’d all be in that one!

If the share value has a downward trend, the 15% yield delivers an ever-downward amount of distribution too. When comparing two funds, regardless of the distribution percentage, it is important to understand the total return potential over time. The yield percentage is not the total return. There may be a time & place that will work for some high yield exposure in a portfolio. But it’s good to understand what you’re getting into. Whenever you are tempted by a high yielding fund, compare the historical returns against a market fund or your favourite ETF. Don’t mistake yield for return. A 15% yield doesn’t always, indeed seldom does, give you back all your money in 4.8 years & then go on to give market beating performance thereafter. While historical performance of any fund is no guarantee of future performance, comparing the total return percentage is a more useful metric for comparing two such different strategies.
And that total return percentage is the number you need to plug into the Rule of 72.

Use the online tools at sites like Portfolio Visualizer, StockCharts & the fund comparison tools at the BMO & Vanguard Canada sites to get a bigger & better picture of the historical performance of different funds. And use the Rule of 72 for total return estimates.
Though you can use it for dividend growth rates too. But that’s a story for another day.

PS … If you do know of a fund that delivers 15% total return consistently, please message me. And don’t tell anyone else ’til I rejig my portfolio!

Important – this is not investing, tax or legal advice, it is for entertainment & educational purposes only. Do your own due diligence & seek professional advice before investing your money.

Lies, Damned Lies, & Compound Growth

The Power of Compound Growth

Compound growth (or losses!) can be confusing. When it comes to compounding, using quick mental arithmetic to make investing decisions can be detrimental to our financial health. If we don’t take the time to understand the power of compound growth, to feel its power, we might not even find the motivation to start saving & investing. That might prove to be a costly oversight down the road. And it’s very difficult to compensate for those lost years later. Life really is too short.

Try this little brain teaser …

If someone offered you a penny to work all day, would you do it?
No, eh!
What if they asked you to work for a full month but, this time, they offered you a penny for the first day of the month & then promised to double the previous day’s pay for you, every day, ’til the end of the month?
If you think this is a trick question, you’re right. But without grabbing a calculator, how much to you think you’d be owed at the end of the month? Take a stab at picking a number now & I’ll share the calculations further down.

Ever since Jack Bogle gave us the low-cost index fund, there has been widespread support for retail investors, particularly younger investors with a long time horizon, to follow that path. Even the inimitable Mr. Buffett recommends low-cost, index-tracking funds for most of us. After taking fees into account, there aren’t too many actively managed funds that can beat the market index over time. The market has grown by about 10% annually for a century or more. If it works like that going forward, a kid saving $100 a week from age 20 to 65 might have a portfolio worth almost four million dollars by retirement. That’s the power of compounding. If the kid invests in an equivalent high-fee fund that reduces that annual growth rate to 8%, the portfolio would be worth a little over two million come retirement day. That’s the power of compounding in reverse! Fees of “only” 2% eliminated almost 50% of the end value. Fees compound too. Just not in favour of the investor.

The magic of compound growth is tough to visualize with any degree of accuracy. I need a tool or a calculator to compare investing returns over time. Particularly when it comes to comparing a growth investment against one that pays a dividend that gets reinvested. While past performance may not be replicated going forward, historical performance can make for some interesting comparisons. And those real comparisons will probably be very different to guesstimates based on my mental arithmetic. Our heads don’t do compounding well. But compounding might do well for us. If we allow it enough time to work it’s magic. Play with a compound growth calculator. It might encourage you to get started. Once you understand the power of compounding, you should be motivated to get started right away. Compounding takes time & patience. But you’ll never truly get to appreciate its value if you don’t start early enough.

What if you’re old already? I know that story all too well. Each investor has a different risk tolerance, level of knowledge, savings rate, & so on. Even two investors with very similar investor profiles may invest in very different portfolios. Compounding doesn’t care. It will do whatever it can with our investments, with whatever time is available. Based on your investing style, plug in the numbers for your timeline, with your expected rate of return. See if the possible outcomes are close to where you’d like to be by retirement day. If not, you might need to save more, sooner, to get there. Or maybe you’ll see that financial freedom is not too far away for you. A compound growth app might be one of the best games to have on a mobile device!

Does your head do compounding well? What number did you come up with from the opening question?
At the end of the first week, you’d be due about a buck & a quarter. Not even enough for a cup of coffee these days. Pretty awful, eh! By the end of the 2nd week, that would jump to $164. Hardly earth shattering. The 3rd week, however, would be almost $21k. Yes, twenty one thousand dollars. Things are improving now. At the end of the 4th week, the number would be almost $2.7 million. And only three days later, at the end of the 31st day, it would be almost $21.5 million.
The total wages due on that penny starter wage, by the end of the 31st day of the month, would be almost twenty one & a half million dollars. Now, that’s some kind of compounding!
How close was your guess!?!

I like the calculator at the Ontario Securities Commission website here. The graph of results here shows a great image of how the power of compounding works better over time. Go play!

Important – this is not investing advice, it is for entertainment & educational purposes only. Do your own due diligence & seek professional advice before investing your money.