Over the past two weeks, I’ve been looking at the top dividend growth US stocks and the top dividend growth Canadian stocks held in the biggest dividend ETFs in terms of market cap. I have explained that by looking at the top dividend ETF holdings, you can build a very interesting list of potential stocks to add to your dividend portfolio.
I started with 2 simple investing principles to build my theory:
#1 Portfolio managers are professionals who have access to more time and resources to build their portfolio than the average investor.
#2 The fact that ETF behemoths maintain a position in a stock and keep buying it ensures a certain level of demand, read value, for this stock.
Based on these very same principles, an investor could think: why should I bother picking my own stocks when I can buy a dividend growth ETF?
This is a legitimate question and depending on which kind of investor you are, ETF investing could be very interesting. Let’s take a deeper look into the world of dividend ETF investing…
#1 Loss of Control
The first obvious reason why you would like to keep your dividend growth portfolio instead of picking a dividend ETF is to remain in control of your portfolio. When I looked at the Canadian dividend ETFs, I found many stocks that I would not personally own. But if I buy the ETF, I won’t have a choice but to buy the package.
The argument that portfolio managers are professionals and have more resources doesn’t mean that they are better than the market or the average investor all of the time. In fact, they can also develop the tendency of believing that they saw something nobody else saw and pick a relatively bad stock thinking it will bounce back. If you like to know what’s inside your portfolio, dividend ETF investing might not be the way for you.
#2 Loss of Dividend Growth
There are 2 factors that affect negatively dividend growth within an ETF:
#1 TheMERaffects your overall dividend yield
#2 ETFs are separately managed stocks and may not follow individually held stocks’ dividend policies
For example, during the last crisis back in 2008, many dividend ETFs reduced their dividend payouts while individual companies didn’t. Many stock holders didn’t feel that payout reduction since many companies kept their dividend as is during the crisis.
So if you compare your chances of increasing your dividend payout over a long period of time, dividend ETFs may slow down your performance. That is, conditional to picking the right individual stocks!
#3 Loss of Control over Dividend Payouts
When a dividend is issued, there are basically three actions you can take:
#1 Cash the payout as a revenue stream
#2 Use the dividend payout to buy another stock
#3 DRIP and increase your holdings in your stock
I personally use the second option right now as I want to build a bigger portfolio with more stocks. Eventually, I will use DRIPs to increase my existing positions once I hold enough stocks in my portfolio. I would not have this kind of choice if I was going to buy dividend ETFs as the payout will be paid “in bulk” and not for individual stocks. So I couldn’t increase my position in KO while cashing my STX dividend payout. I would have to either increase my position in the ETFs or cash my dividend payout.
When ETF Investing Could Be Very Interesting
What I don’t like about dividend ETFs is definitely the lack of control over the core of the portfolio. As individual investors, I think we all think we can beat the ETF by our own investing methods. I know, it’s probably not right, but the psychological aspect of investing is often stronger than the rationale!
The more I think of ETF investing, the more I look towards a different portfolio model. What if you could build a core of ETF INDEXES (not dividend) and add dividend growth stocks around it to boost its yield?
Index investing provides a huge advantage when compared to stock picking and it’s called diversification. The fact that you are mixing a growth (index) strategy with a value (dividend) method should ensure a smoother investment return year after year.
The way I manage my dividend portfolio is getting closer to this technique right now as I’m buying indexes with my dividend payouts until I have enough cash to buy another position for my portfolio. Once I have all my stocks picked, I might start building a core in indexes while my dividend stocks continue to pay me.
What do you think of this investing technique? Have you ever considered mixing indexes and dividend stocks in the same portfolio?
I am using index ETFs for REITS and bonds only. I feel it’s the best way to diversify in these asset classes. As for dividends, I find it is easy to diversify by buying 3 or 4 blue chip good dividend paying stocks in each of the main sectors of the TSX or S&P 500. Why pay a MER for nothing? The only dividend ETFs I would buy is if I wanted some international exposure to dividends i.e. Europe, Asia etc.
As individual investors we think we can beat the indexes. We think this but it is a dangerous thought in my opinion. If it was that easy mutual fund performance would be much better than it is. Professional active investment managers have a miserable record when it comes to beating indexes over the long haul.
I am a committed income investor but I have learned the hard way that diversification is essential. Even supposedly rock solid companies have cut or suspended dividends or been acquired and changed policies. GE, US Banks, MFC, BCE (Teachers buyout period) all changed payouts dramatically during in recent years. Tax law and interest rate changes can also impact dividend stocks and we have no control over these.
Dividends are attractive and individual stock picking is tempting but if you don’t have the funds to diversify: Sectors, Companies and Asset Classes, then low cost ETF’s can help broaden the base.
I like the way you manage your portfolio. It’s hard to manage indivudal bonds as most new issues are picked-up by big firms and small investors don’t have access to them. Going ETF is probably the best way to do it at the moment!
My Own Advisor
“What I don’t like about dividend ETFs is definitely the lack of control over the core of the portfolio.”
I wrote about this fact this summer myself:
I use a blended approach for our portfolio. 30 dividend stocks from the US and Canada and index everything else. It makes my portfolio pretty much bulletproof.
Dividends are approaching $6,300 per year and my wife’s portfolio is almost 100% indexed. Over time, I will continue to let the stocks I own, DRIP, so money makes money, and any leftover cash from dividends paid will be used to buy indexed products with the cheapest MER like XIU and VTI.
The best of both worlds 🙂
$6,300/year is pretty good! how many years did it take you to build that?
Interesting views. I personally like the 80% index 20% individual stocks approach, because it allows you to boost yield while taking reasonably low risk.
Canadian Couch Potato
Mike, can you please elaborate on this statement: “During the last crisis back in 2008, many dividend ETFs reduced their dividend payouts while individual companies didn’t. Many stock holders didn’t feel that payout reduction since many companies kept their dividend as is during the crisis.”
ETFs pay out all dividends received by the companies in the fund. Your comment suggests holding a stock directly is somehow different from holding the same stock within an an ETF.
I’m glad you read my blog, I didn’t know you were a reader 🙂
If you look at the following ETFs, they have reduced their payouts between 2007 and 2009:
DLN, PEY, PFM, SDY, VIG, VYM.
For example, if someone would have kept MCD, KO, JNJ, etc they would have seen a dividend increase from 2007 to 2009 as compared to a dividend decrease with ETFs.
Not quite sure why it happened, but if you look at graphs on Google Finance, you see it.
Hi, I just signed up and therefore not quite sure if my
questions are appropriate but anyway nothing ventured so they say..
I own some closed end funds DGS, LBS plus a few stocks that
appear to be losers such as Avenex (AVF) and Poseidan,Rona-
I waited too long to dump these unfortunately & wonder if there
may be any thoughts or ideas re choices? I was going to dump all of them Monday but thought I would send this first.
unfortunately, I’m not in a position to recommend to buy or sell anything. You should definitely meet with a broker or financial advisor for specific advice.