Dividend Investing: Is it Right for You?

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I’ve been getting a ton of requests for an episode that talks about dividend investing in Canada, so a big thanks goes out to all the listeners who reached out and made the request by either leaving a review on iTunes, or signing up to the free Build Wealth Canada newsletter and asking me in the comments section after signing up.

So based on your requests, today I’m excited to have Ryan Modesto on the show who is the dividend expert and Managing Partner over at 5i Research. If you recognize the name, it might be because you saw him on TV over on the Business News Network (BNN), or you might have read one of his many articles or analysis as Ryan literally analyzes Canadian companies every day to find the best ones to invest in, especially if you are a dividend focused investor.

Now if you’re new to dividend investing then don’t worry, we’re going to start off at the basics, build a good foundation, and then move our way over to some more advanced questions once you’ve got a good handle on things.   

Ryan has also been generous in providing Build Wealth Canada listeners with a special offer where you can get your investing and dividend questions answered by him, and learn other dividend investing best practices by getting a free trial membership over at 5i research.

Questions Covered

1. 1. For those Canadians new to this type of investing style, can you explain what dividend investing is?

1. 1. When should someone consider doing dividend investing? (i.e. Is there a particular life stage when it’s most appropriate?)

1. 1. Is there a type of person that is most suited for this type of investing? (ex. time commitment, personality, etc.)

1. 1. What are the pros and cons of this investing style vs something like index investing, mutual fund investing, or stock picking for growth?

1. 1. The idea of investing to “live off the dividends” sounds very tempting to Canadians. How realistic is this? What is actually needed to pull this off?

1. 1. What are some of the top mistakes Canadians make when investing in Dividends? (ex. Chasing yield)

1. 1. At 5i one of the things I noticed you do, is that you have sections of the site dedicated specifically for dividend investors, and I noticed that in there you recommend primarily Canadian companies. Can you explain why that is? (i.e. preferential tax treatment, anything else?)

1. 1. Peter said (in a previous interview)  that at 5i you like companies that have a growing dividend. If somebody is researching a company themselves, how can they check if a company is growing its dividend?

1. 1. What are some good resources for somebody that is considering, or wants to learn how to do dividend investing?

1. 1. I know you guys offer a lot of help on this to 5i subscribers so feel free to talk about some of the resources that you have available for investors too.

1. Can you tell us more about the free trial and question that you offer to Build Wealth Canada listeners, and where can listeners learn more from you?

Questions and Answers Summary

Please treat the answers below as a review/summary, but don’t just read the bullet points below. It’s important that you watch or listen to the entire interview to ensure that you interpret the summary points below correctly (i.e. In the right context).

Question 1:
For those Canadians new to this type of investing style, can you explain what dividend investing is?

Answer: 

A Dividend is:

• A distribution paid by the company to the shareholders
• Paid out of company’s cash flow, from their net income

Dividend Investing:

• Usually a mature company
  (in the mature stage of their life cycle)
• Usually has relatively stable and predictable cash flows
• Usually a safer and established company
• Helps you hold investment long term since you know dividend payments are coming.
• Psychologically helps you ride out the storm
  (due to incoming dividends)
• Can reinvest the dividends:
  • This lets you compound your money by investing more in the same company, or you can take that money and invest it somewhere else like an index ETF, another company, etc.
• Are tax efficient compared to fixed income (Canadians get dividend tax credit) .

Question 2:
When should someone consider doing dividend investing? (i.e. Is there a particular life stage when it’s most appropriate?)

• Younger investors should be more growth oriented (due to longer investing timeframe before retirement).
  • i.e. Younger investors far from retirement should focus on growth companies, as opposed to mature stable companies that tend to issue dividends.
• With dividend focused companies, you are less likely to get as much capital gains as with growth oriented companies.
  • Mature dividend paying companies don’t grow as much but issue a more reliable dividend.
  • Growth companies often reinvest their profits instead of issuing them as dividends so that they can grow further.

Conclusion:

• With dividend paying companies, the growth potential isn’t as high, but in return you tend to get more stability (less volatility), and a more reliable income stream.
• Therefore, dividend investing is better suited for an older investor that wants stability and income, as opposed to growth.
• Not everyone wants to take the time to find those higher risk companies. Sometimes people just want to invest in more mature companies and get a more predictable return (even if they’re younger).

Question 3:
How common is it to transition from being an index investor when you’re younger, to becoming a dividend investor when you’re in retirement?

Answer:

• Hard to jump from being an index investor to a dividend investor at older age.
• From a psychological point of view, it would be very hard to transition.
• Could cause panic reactions, panic selling.
• Another Option: You can get a high dividend paying ETF instead.
  • This way you are still getting a lot in dividends, but are now also more diversified since it’s an ETF that holds a collection of stocks (as opposed to you just buying a small group of individual companies).
• Another Option: You can also pepper in high dividend paying stocks to your existing portfolio (ex. Adding some good dividend paying companies to your portfolio of ETFs)
  • This can help elevate your cash flow while not putting up too much risk.
• Should ease yourself into that transition from growth focused investments (when you’re younger) to dividend focuses investments (for cash flow and stability) when you’re older. Don’t just do it all at once.

Question 4:
Is there a type of person that is most suited for this type of investing? (ex. time commitment, personality, etc.)

Answer:

Works for any type of investor:

• Passive investors like it because it pays you to wait.Can set it and forget it.
  • Remember to buy and hold companies with good stability and performance.
• Works for active investors too:
  • Can get in early on growing companies that are just starting to issue dividends.
  • This way you’re getting in early so you receive dividends and good capital gains if the company grows.
  • Markets generally have a hard time pricing these companies so there is opportunity out there.

Good for Impatient Investors:  If you hold a good company and it’s temporarily at a losing position, at least you’re receiving dividend payments from it to help offset emotions of wanting to sell it (because it might have temporarily dipped in the red).

• You can protect yourself against knee jerk reactions if a company has a bad quarter for example, and the stock price drops.
• If stock drops, you can actually take dividends from that stock and buy more of that company since price is temporarily deflated, or you take that dividend money and diversify elsewhere (another company, ETF, etc.).

Question 5:
What are the pros and cons of this investing style vs something like index investing, mutual fund investing, or stock picking for growth?

Answer:

Two Main Cons:

1. Time it takes to manage the portfolio
2. Concentration risk

Concentration Risk:

You’re taking company specific risk if you’re just a dividend investor since you aren’t as diversified as if you were doing broader investing (i.e. buying indexes of broad markets for diversification).

If you’re only focusing on dividend payers, then you’re also taking on style risk since dividend investing falls in and out of favour in the markets just like other investing styles.

Pros: Can be rewarding personally and financially.

• Satisfying having something more diversified as far as sectors go compared to the TSX.
• TSX not very well diversified across industries in Canada.
  • TSX index in Canada is overrepresented by financial companies and energy companies.
• You can diversify to not be over-concentrated in those sectors: You can spread your risk among the sectors better, and potentially get higher return at less risk because you’re strategically picking the right companies to invest in (based on how solid a company is), as opposed to just buying all companies in the index (which includes good and bad companies).
• Lets you avoid fees: You buy stock and once you own it there are no fees (i.e. no MER like with mutual funds and ETFs)

Aside: Closet Indexing.

Mutual funds charging you the high fee (ex. 2.5%) but are just holding an index (something you can hold yourself for a lot cheaper with an ETF)

“Closet indexing is the common term used to describe funds that claim to be actively managed but in fact are not sufficiently differentiated from the benchmark to support that claim.” (Source: Morningstar UK)

Question 6:
The idea of investing to “live off the dividends” sounds very tempting to Canadians. How realistic is this? What is actually needed to pull this off?

Answer:

• Depends on what living comfortably means to you.
• If you want $100,000 a year in retirement through dividends then it’s tough.
• If you want $30,000 from dividends then totally reasonable. You can get to $50,000 a year in income by adding other income sources that you’ll get in retirement like CPP and OAS.
• Most Canadians can live fine with $50,000 a year in retirement.
• TSX yields about 3.3%. So you Need $910,000 portfolio to get that $30,000 income per year (before taxes). This is attainable if you are a decent saver but:
• If you’re more selective with you portfolio (i.e. where you aren’t just buying the index), then with relative ease you can get 4% yield.
• You could get 4.5% yield if you’re willing to do a little extra work.
• If you’re getting 4 to 4.5% yield, then now to receive around $30,000 a year in dividends you only need a portfolio of around $650,000 to $750,000 (which is now very attainable for most Canadians).

Question 7: What are some of the top mistakes Canadians make when investing in Dividends?

Answer:

Mistake #1:
Assuming that dividends are safe:

• Dividends are not fixed income.
• They are paid at the discretion of management.
• They can be cancelled, so don’t rely on just dividends and don’t assume that they are guaranteed.
• A company will do what they can to keep issuing dividends because their stock price will take a hit if they stop.
• But if things get rough at company, dividends tends to be the first to go.
• This is why you want to invest in operationally sounds companies that have a history of paying the dividends (and are therefore less likely to cancel their dividends in the future).
• Remember that even the big stable banks temporarily stopped their dividends during the 2008 crash, so never be reliant on just dividends.

Mistake #2:
Investing only in dividend paying stocks:

• Dividend stocks are great but you don’t want all your eggs in one basket.
• You want to be well diversified. You can have some dividend stocks to help grow your income more and potentially get a boost in your returns, but you don’t want to invest only in that.
• In other words, dividend stocks are great, but you don’t want to be 100% in dividend companies because now you’re running into diversification risk.
• Some years they’ll do great, other years they won’t do as well, so you want it as a part of your overall portfolio. You don’t want to be 100% in dividend companies as now you’re taking on unnecessary risk.

Mistake #3:
Chasing yield:

• If there’s a high yield it’s usually there for a reason.
• Don’t pick a company just because it has a high yield.
• In fact, consider an abnormally high yield as a warning sign.

Question 8:
At 5i you have sections of the site dedicated specifically for dividend investors. In there you recommend primarily Canadian companies. Can you explain why that is?

Answer:

• You want a big chunk of your dividend portfolio in Canadian companies because of the tax advantage and flexibility.
  • If holding US companies then you want them in RRSP to help with taxes (i.e. US and Canada tax treaty)
• With Canadian dividend companies you have more options of where to keep those investments in a tax efficient manner (RRSP, TFSA, unregistered accounts)
  • i.e. You don’t have to worry about getting charged withholding taxes by a country when you’re buying Canadian companies.
• 5i Research covers Canadian companies so you get that analysis too (as a member) to help you make the right decision on the best companies to buy.

Thanks for reading! You can get your investing and dividend questions answered by Ryan when you sign up for the free 1 month trial of 5i Research Here.

In Closing

I hope you enjoyed the interview with Ryan. Remember to Click Here for your free gift from 5i Research where you can get the free trial and get more of your investing and dividend questions answered by Ryan.