19 Questions Answered on Dividend Investing Strategy

Q&A - Dividend Investing Strategy

Investing is a journey and rarely do we know everything when we start. We have a lot of questions to learn about investing and avoid making mistakes (and losing money)

The best way to learn is to ask questions. My readers regularly ask questions (thank you) and I did a weekend blitz to get as many questions as possible and answer them.

Investor Q&A

The questions are broken down into 4 categories to help find what you are looking for.

  • Dividend Investing Strategy
  • Stock Research (Coming soon)
  • Income Taxes (Coming soon)
  • Stock Tips (Coming soon)

Dividend Investing Strategy Q&A

Q.Why do you invest so heavily in equities and not in bonds or other fixed income strategies? The recommended ratio for a conservative portfolio is in the neighbourhood of 40% equities / 60% fixed income, depending on risk tolerance. Do you feel investing nearly 100% in equities is a safe strategy for someone planning retirement within the next several years?

A.Conventional wisdom around investing is often based on controlling fear and it’s usually the fear of seeing the value going down as opposed to the value really being down and taking a loss. The ratios of bonds vs equities is based on avoiding waiting a few years for a recovery. Perceived loss is different from actual loss.

I am 100% in equity because I understand what the stock market is. I am prepared to wait 3 years for a recovery of stock prices as I trust my investment choices are in companies with a solid business. The stock market doesn’t always behave rationally.

I also started with the concept of ratios but as I invested more and more and built confidence, I asked myself why I should have bonds? Don’t get me wrong, when I am ready to retire, I will have a cash ladder strategy, possibly with bonds in order to have a few years of cash and to never be forced to sell at the wrong time. I can do that switch overnight though. I do not have to slowly grow my bonds.

Another factor is that I am highly employable in the tech industry. It’s easy to get a job and work. That’s a type of safety on its own.

Q.Do you have a rule that you go buy that tells you to take your profit on all or part of the stocks you own in a company?

A.I will take profits when my holding becomes a large percentage of my portfolio. Once it reaches above 6%, I start considering taking profits. I don’t take the profit to lock it in in fear of losing though, I sell because I feel too exposed to one holding in particular. I will also wait for a bit in case there are fluctuations as I don’t tend to sell winners.

If the stock drops the dividends, I will sell.

Another sell consideration is if there is a stock I want to take a position in and I don’t have money, I will consider selling my least performant stock.

Last but not least, I review my holdings to ensure it still matches my purchase reasons. If it does not, I will sell. This is part of my portfolio stress-test portfolio review.

Q.How do you determine the most appropriate time to sell a stock? If you could provide some of your insight on a few key metrics or some other technique for spotting trouble with a company I would be very appreciative.

From my experience while investing over many years I have relied on the newspapers (Financial Section), Investor newsletters (generally they tell you to buy OR hold but seldom tell you to outright SELL), On-Line financial sites and many other areas. However, I generally invest in blue chips stocks which pay a dividend. But, I have been caught (eg: Nortel, Crescent Point, Maxar Technologies Inc., Encana, Yellow Pages (Reverse Split), AGF Management Limited, TransAlta Corp.).

A.First, I start by buying into the business and that’s not easy to assess a business. I try to think if the business is like a toll booth and can generate moneylike clock work. Those companies will often be stocks that are market leaders and have a monopoly or an oligopoly.

As for metrics, here are some to consider.

  • The PE vs historical or sector can be an indicator on the premium.
  • Reduced earnings for a few years.
  • External factors such as NAFTA or other economic influences.

Aside from Nortel which was a market leader, the other stocks are simply high yield stocks which should be the first warning. Some of the stocks you lists are stocks I looked into for the yield when I started and switched to dividend growth after learning some hard lessons. No dividend growth means no earnings growth.

Q.Do you believe in selling covered calls? If so, what guidelines do you have on price and exercise date?

A.I have never sold covered call but I have wanted to try it out. I just never got around to trying it out.

Q.Why invest in stocks that pay less than GIC’s? With the volatility that is inherent in todays markets, why do you feel investing in stocks whose dividends are less than the returns of a GIC a better investment choice? I know they could perhaps increase in NAV value, however, if you are seeking dividends and not capital appreciation, why choose them over a better paying GIC?

A.I started dividend investing in my mid-30s as a safe way to invest and invested in high yield stocks but lacked growth. In retro-spective, that hurt my portfolio growth.

I switch to dividend growth investing with lower yield and my portfolio is all the better. Much higher appreciation from total returns. I can use that and invest in higher yield stocks when I retire (but not too high yield). Portfolio growth is the key before retirement as dividend income is a factor of overall portfolio value.

Do note that in retirement, there is still the concept of keeping up with inflation. To keep up with inflation, you need dividend growth higher than inflation. I repeat – dividend growth higher than inflation as opposed to a dividend yield higher than inflation. Your yield is what provides your income whereas the growth is what keeps up with inflation.

In a portfolio growth, I strive for 10% dividend growth.
In a retirement portfolio, I could go with 6%-8% dividend growth with a higher yield (think of the banks).

Q.What advice would you give to a young adult (22 year old) who wants to begin saving and investing?

A.This is a long answer and I have tried to answer it in the Beginner Model Portfolio. In a way, it’s a note to my young self.

Q.Your thoughts on buying dividend ETF’s like VDY, ZDV or XDV (CDN$) or just index ETF’s like XEI or XIU instead of individual stocks which the average person doesn’t have time or expertise to manage?

I know there is a small price to pay but it’s not a lot considering the expertise the portfolio managers have. The question is, for a long term holder, rather than picking and choosing individual stocks, why not buy the broad index and leave it over a long period of time? That way there is no emotion of second guessing and no choices to be made. I’m talking about the average person who has little expertise and time.

A.If you are going to buy an ETF, just stick to an index ETF. I don’t see why you want to use a dividend ETF unless you are in retirement seeking income.

Many investors buying dividend stocks have the goal of retiring from the income of the portfolio and that requires considerations and planning.

One big challenge to figure out in retirement is to not outlive your money.

Q.I am starting out with approx 150k, I know you think it is best to limit your total portfolio to 30 stocks but how large should I let my positions get before buying a new stock?

A.I have 30 stocks for an $850K portfolio and I limit the maximum exposure to 6% per holding. For the longest time, I would limit my exposure by sector as well but I find that by industry gives you a much better understanding of your exposure.

Look at it this way, if you are not willing to invest much in one stock with the fear of losing, then you might not want to invest in the stock. I keep my limit to 6% in order to avoid a large swing in portfolio value.

See the Beginner Model Portfolio on how to start.

Q.My question relates to dividend reinvestment plans. I read about it in one of your blogs but didn’t fully understand its implications.

It’s the last column on your monthly dividend list. I always ignore it. Guess it’s because I’m still early stages and haven’t accumulated that much in dividends.

Can you explain what it’s all about? How to use it? I believe it’s part of your strategy, can you explain what is the reason that you use it?

A.The DRIP plans are good if you are willing to make regular contributions regardless of purchase price and accumulate fractional shares.

Fractional shares from your purchases and the dividends will start compounding fast as you are putting all pennies to work.

A great option for teenagers or students until you start focusing on a TFSA or RRSP. When I started, I paid attention to the details and the DRIP discount, but I do not anymore. I do have 2 ongoing plans with Telus and TC Energy with monthly and quarterly deposit.

Q.How high can a dividend go before it becomes at risk?

A.In general, high yield investments are not sustainable. For some stocks, the high yield may go on for a while making you think it’s all good but the business reality will catch up.

Each industry and sector have their ratios somewhat defined by the business, their earnings and the cash needed to reinvest in the business to stay competitive. If the yield is significantly above the average, you enter the risk zone.

Q.ETF vs Individual stocks which one offer greater returns in the long run?

A.Flip a coin. Indexers will tell you that you cannot beat an index and others will say you can beat the index. Unfortunately, it’s all about you and your emotions will be your worst enemy.

You can even fail with an index by ignoring the US market or deciding to choose the wrong ETF. What you understand and can apply successfully is much more important. For example, Canadians tend to be home bias in their investing and will not invest enough in the US.

Q.Do you think a dividend growth based portfolio is better or a constant/fluctuating high dividend (7-10)% portfolio is better. At 19 years old I’m wondering which kind of stocks I should be going for.

A.High dividend yield do not have growth and are a warning sign of difficulties ahead. You do not want to compare high yield with interest income.

To build a growth portfolio, it is better to focus on dividend growth. Dividend growth implies growth in earnings and therefore stock price.

I know it’s easier to see a high yield and do that math but you have to find the dividend growth. To filter stocks, I use the Chowder Rule and it has been good.

Q.How much money do you need to have in a trading account to make enough to live comfortably in the GTA?

A.It really depends on your cost of living and your investment decisions. Not everyone spends the same amount in the Greater Toronto Area, not everyone has a car for example and the expenses you have are yours and yours alone. Comfortable is also a subjective word that implies a different lifestyle for different people. You have to establish the monthly needs for housing, commuting, food, clothing, pets, entertainment and holidays. They are the big buckets and there is a lot more to break down in a budget.

However, let’s just look at one example regardless of where you live, if you spend $4,000 per month, or $48,000 annually, you need to have at least $48,000 in income. If you look at the XDV ETF (one of the Canadian Dividend ETF), the yield can average around 5.00%, you need about $1M to generate that income. That’s the simple math not taking into consideration income tax and inflation protection. Quick math for taxes, try to get $60K in income, you now need $1.2M in a portfolio.

The challenge is that 5.00% is a high yield and I am not sure anyone would have that. My portfolio has a yield of 2.66% and I think 3.50% is probably a good average for a well diversified portfolio. Most index ETF will have a dividend yield of 1.50%. Through conversations, I find that those with a high yield portfolio tend to stress over the market swings a lot more than others implying they are taking more risk to generate income and it is creating stress.

Q.For all retirees (70+) who naturally have a restricted time horizon, is investing in Cannabis Stocks (Aurora, Canopy, etc.) considered “too risky” a proposition? Some financial advisors say it is “too early” to invest in such companies. What is your opinion?

A.I believe that Cannabis stocks do not belong in a retirement portfolio. Just think about the business model, how can you establish sales estimate and forecast 3 or 5 years out? The price of a stock is based on the future value and it’s based on the earnings.

The “too early” implies that it’s not stable like a blue-chip stock. Flip the question aside, are you ready to invest in the Uber IPO? or other IPOs at your age? Overall, it’s a long shot and is akin to placing a bet.

Q.What is your opinion in holding US or International stocks in your TFSA, such as, Visa, Brookfield Infrastructure Partners, Brookfield Property Partners, Apple, etc. Yes, there is a withholding tax for such securities, but can this can be considered “negligible” compared to the advantages?

A.First, Brookfield Property Partners TSE:BPY.UN and Brookfield Infrastructure Partners TSE:BIP.UN are Canadian holdings. They also pay a distribution (not a dividend) so there is a chance to have some foreign withholding tax but that’s the same thing with RioCan TSE:REI.UN when it had purchased properties in the US.

Second, I focus on growth. If Apple NASDAQ:AAPL or VISA NYSE:V are going to make me more money than a Canadian stocks, I will hold US stocks in my TFSA. In fact, I hold VISA in my TFSA and I hold Google in my non-registered account (the only non-dividend stock I hold).

Q.What criteria do you use for determining the dividend safety of an investment? Please be as specific as possible, describing how you evaluate safety of different types of investments; such as most c-corps, utilities, REITs, BDCs, and mid-stream co’s.

A.Dividend safety in my strategy is the guarantee the dividend will be paid and not reduced.

First, I avoid high yield stocks. Anything above 5%, while attractive for income, will usually never last. Sometimes it drops dramatically after 18 months but it eventually drops. Simply because the business cannot afford high yield and grow the business.

Second, I will look at historical yield to ensure the pattern is in line and the same with the dividend payout ratio to ensure the ratio isn’t the reason for the yield.

Third, I will look at the sector and industry to ensure it’s in line. If it’s out of line, there is a risk since all companies in the same business will tend to operate similarily. There usually is convergence of cost and profit margins.

Q.I am trying to teach my nephew about dividend investing. My idea is to open an account and purchase 4 dividend paying stocks. Starting capital $2,000. Each year we would add another $1,000. We would have a roundtable discussion on what stocks to pick. What four stocks would you recommend? This would be a ten to fifteen year project.

A.Congrats on the project. Best financial education.

Based on my experience navigating the Canadian Stock Market since 2009, I would have to say to pick one of the market leaders in those 3 groups.

  • RY or TD
  • BCE
  • FTS or EMA

The last investment I recomment is an S&P 500 index ETF like VFV from Vanguard. The US is a much bigger market and economy to be in.

Q.I’m investing with a non registered account and mainly my focus has been on Canadian stocks, I was doing research and there are some out there who think due to tax reasons this account should hold solely be invested within the Canadian market. I think diversifying into other markets would be ideal. I was curious to your thoughts?

A.Investing, when you take into considerations risks and taxes, can get complicated. To simplify it, guidelines are outlined as to where it’s best to hold certain equities. Those guidelines are good but at the end of the day, it’s about the most profitable investment for your money within the risks constraint you have.

In a non-registered account, profit is the dividend plus the stock growth minus the tax. For many, the dividend is visible and the stock growth is not so visible since it is extrapolated based on many different qualitative and quantitative data points over time. If you hold a US stock in a non-registered account, there is a 15% tax on the dividend and the capital gains is the same rate as a Canadian stock.

A growth stock tends to have a low yield and 15% on 1% is a small price to pay for a growth stock. If you have an income stock with a high yield, chances are the profit is mostly from the yield so you give up 15% of your profit. Most investors do not have proper performance tracking and do not see the real rate of return on their investment. I know my ROR for the portfolio and each stock which allows me to assess whether or not the tax is worth paying on the dividend. Your official dividend ends up being the dividend yield times 85% since 15% goes back to the US government.

I am happy to hold stocks that pay around 1% in dividend as they are growth stocks during my portfolio accumulation years. Even with a low yield, I do invest in dividend growth stock with 10% dividend growth target.

Q.My kid is turning 18 and plan to contribute in TFSA as soon as he’s eligible and every year regularly. How should he starts his portfolio?

He’s not too interested in ETFs. Due to his long time horizon what would he be looking at to construct his dividend portfolio. Do you think he should buy Canadian banks? Start with only 2 to 3 companies since he can only have $6k in TFSA? Any feedback would be appreciated.

On a side note, do you think start with ETF would be better? Basically what would be a good strategy for a kid who’s just starting to invest at 18.

A.I shared my opinion on a few stocks to start with for kids in a different question as well as providing details on a beginner portfolio model.

With that said, the concern for an 18 year old might be to want to strike rich and the urges to do so will be around. The feeling and confidence to do it again with more money will grow.

In this case, it might be prudent to follow the beginner model portfolio and also allocate a percentage that can be invested in risky stocks. The biggest learning for your child will be to establish a process and maintain emotions in check.

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