*This article is for more beginner investors, but it was inspired by many emails I received.
If you follow this blog from time to time, you have already noticed how much I prefer dividend growth stocks on top of high yielding companies. Some may think that it’s because of my age (36) and that I have about 50 years to invest my money. But the real reason is because I rather focus on my total return than my yield. In the end, if my portfolio yields 7% but has lost 25% of its value over the past 3-4 years, I’m not a winner. When I discus stocks that show great potential but very low yield such as Visa (V) at 0.62% or Microsoft (MSFT) at 1.66%, I often receive comment that they are nice stocks, but not interested. Recently, one of those comments caught my attention;
“A 2-year GIC currently yields about 2.6%. The principal is federally insured. It doesn’t get better than that. If I am going to invest in a company, then I expect a premium for taking that risk.”
Hence my question: Should You Compare GIC Rates with Dividend Yield?
Investing as a source of income
When you look at financial theory, the investment expected return is a combination of the interest paid on a “risk-free” investment (such as a 30-day US T-Bill) and the risk you are taking (e.g. the possibility of not getting your money back). In its most simplistic way, a GIC offers a “risk-free” investment. If we take the example of an fed insured 2 year GIC at 2.6%, the most important risk the investor takes a risk of liquidity (hence the higher rate then a 30-day T-Bill). This means the investor can’t have access to his money before 2 years. Some banks will allow a withdrawal or to break the contract, but there will be penalties. The second risk is obviously inflation. But over 2 years, this is not a big one.
Now, if you invest in dividend-paying stocks and intend to live off those payments, you may be tempted to compare your GIC yield (risk-free) to your portfolio. But I’m not sure it’s fair to compare investing $10,000 in Microsoft (MSFT) at 1.66% vs investing in a GIC for 2 years at 2.60%. On one side, your $10,000 could worth a lot less (or a lot more) in 2 years as the GIC will show the same value. Also, MSFT will pay its dividend quarter, if you hold a GIC, you will need to wait for a least a year (if interests are paid annually) or even 2 years (if you have chosen a compounding interest). Therefore, you can’t really use a GIC as a steady source of income unless you split your money into multiple expiry dates and make a huge GIC ladder out of it.
Even the yield is not safe
The other way around is also true. An investment in a REIT paying 6% yield is not a good base to compare it with a 2-year GIC. Some REITs are incredibly solid (here’s the REIT list you are looking for), but some of them may cut their dividend at one point in time. Keep in mind that it’s not because a company pays a dividend that it is safe. Talk to Cominar (CUF.UN.TO) shareholders for fun…
Why do you separate the yield out of the total return?
There is one concept that I never understood; some investors don’t care about their total return, they just focus on their yield. In other words, they rather have a portfolio paying 6% yield and showing a total return of 7% than having a portfolio paying a 2.85% yield but showing a total return of 10%.
As an investor, my goal is to maximize the return on my investment. I don’t really mind if it’s coming from dividend or if it’s coming from capital appreciation. I just want to make sure I make money on my hard-earned bucks!
Market fluctuations will happen from time to time and be focusing on total return over a short period of time is a mistake. Your portfolio can lag the market for 3-4 years and that’s totally fine. One should not chase returns. However, when you look at a 5-10 years horizon, you should be able to generate more than a dividend yield out of your portfolio. If you can’t, you are wasting lots of time and energy for nothing. It’s like running 5K and eating a burger with fries right after!
Conclusion; the GIC rate has nothing to do with the dividend yield
There are so many differences between a stock and a GIC that I’m shocked one investor would make a direct comparison. We are talking about investing return, fluctuation, liquidity, etc. But if you really insist on comparing both, you should compare the total expected return. Therefore, while the GIC expected return is quite obvious, you should also try to determine at which pace the company would grow in the next 2 years (not that hard) and apply the same PE ratio. You would get a better idea of where you should invest.Google+