Henry Mah from “Your Every Growing Income” blog posted a questionnaire for income investors and I thought it would be useful to help summarize my investment principles in a single post.
If you are a regular reader, you’ll know that while I’m a dividend investor, I’m also an index investor at the same time. In other words, I take a hybrid approach to investing.
I’m generally a dividend growth investor for my Canadian positions and an index investor for my US and international positions. While I started off being a dividend investor for my US positions (in my RRSP), I have been slowly moving this to an indexed portfolio using some combination of Vanguards VTI, VXUS and/or iShare’s XAW and XUU depending on the portfolio (see tax efficiencies of ETFs).
Why do I like dividend growth investing? For a number of reasons:
- It can provide a passive income stream for life (and with raises);
- It encourages buy and hold for the long term;
- Canadian dividends are extremely tax-efficient (when there is little/no other income); and
- Living off dividends, even though requires a larger portfolio, reduces sequence of returns risk.
I’ve been building my dividend portfolio since 2008 and it has grown from producing $100’s per year in dividends to $50,000+ in dividends so far in 2019. We are just about to hit our cross over point which is when our portfolio income surpasses our recurring annual expenses. At that point, we’ll hit the financial independence milestone, which will be a big one for us.
So on the topic of dividend investing, let’s get into some question and answers.
1. Which stocks should you buy and why?
For dividend investing, I like to buy companies that have a long history of increasing their dividends on an annual basis. These companies are typically larger blue-chip companies with a competitive advantage and lots of cash flow. Here in Canada, companies like Canadian Utilities and Fortis have 45+ years of increasing their annual dividends. For more ideas, you can view a list of the top 22 dividend growth stocks in Canada.
In my last financial freedom update, I provided a list of my top dividend companies by the position size, and they included:
- Emera (EMA);
- TransCanada Corp (TRP);
- Fortis (FTS);
- Bell Canada (BCE);
- Canadian Utilities (CU);
- Enbridge (ENB);
- Bank of Nova Scotia (BNS);
- Royal Bank (RY); and,
- Telus (T).
2. How should you evaluate the merits of the stocks you are considering?
I wrote about how to build a dividend portfolio, which included how I go about picking dividend stocks. Here are some of the high-level criteria that I consider before making a purchase:
- Sector Diversification – Since a large portion of our portfolio is Canadian based, I try to diversify by picking dividend stocks by sector. Some use broader sectors, I tend to use: telecom; pipelines; financials; resources and materials; utilities; health care; consumer; industrials; real estate; and, technology.
- Dividend Growth History – As previously mentioned, I follow the dividend growth investing strategy, which means that I tend to choose dividend stocks that have a history increasing their dividend annually.
- Earnings History – Even with a solid dividend growth history, a safe bet is to make sure that their earnings are growing with the same trend as well. It may be a warning flag if earnings are decreasing while dividends are increasing. It may only be a matter of time before dividends will need to be reduced, or worse, eliminated.
- Yield above 2% (but high yields may be a warning) – As my plan is to eventually live off dividends one day, I prefer to be rewarded with a yield that is higher than 2%. Ideally, the yield would be greater than 2.5% but less than 6%. Why not the higher yield? Generally speaking, if a dividend stock averages in the 3% range over the long term, but then spikes to over 6%, it could be an indication of a dividend cut coming as high yields can be unsustainable. On the other hand, it could also mean that it’s oversold and a value play. It really depends on the situation which means that more research into the company is warranted.
- Market Cap – My core dividend positions are generally larger market cap companies (ie. big company) with a long history of dividend increases and a long term competitive advantage.
Here are more details on how to build a dividend portfolio.
3. When should you invest more money into new stocks or the ones you already own?
As mentioned above, I like to purchase dividend stocks that “fit” into my overall portfolio. I like to spread my portfolio of dividend stocks across sectors in Canada, and purchase index ETFs for international exposure. I typically do not let any single position exceed 5% of my overall portfolio.
In terms of adding to positions, I like to add to stronger dividend stocks when their yields are above their 5-year average. Since the yield is a ratio of the dividend/share and the stock price, rising yields mean a sinking stock price. While lower prices can be a good thing, when yields get really get out of whack, it may be time to step back and reassess the business as to why the price has dropped so dramatically.
Here is more detail on when to buy dividend stocks.
4. When should you sell your stocks?
As a buy and hold investor, it’s pretty rare for me to sell my positions. After all, I’m focused on building my passive income, and selling a position would result in reducing my income. The exception is when a company cuts or eliminates its dividend.
While it’s not often that a dividend growth stock cuts their dividend, it can happen! In 2019 so far, SNC Lavalin and Dorel Industries have both cut their dividend.
5. Should you be worried when the market and prices are going down? Why?
If you build a portfolio full of companies with a strong track record, broad market sell-offs are a gift for the investor still in the accumulation stage. As mentioned, lower stock prices mean higher yields, which is one of the key metrics for income investors.
For those in retirement, spending dividends only during down years will help mitigate the sequence of returns risk.
6. Should you worry about Asset allocation and rebalancing? Why?
While I don’t personally own a lot of bonds, I do believe in the merit of bonds in that they can help smooth out the bumps along the ride. While it can provide a slight drag on the portfolio over the long term, if it can help an investor stay invested through the tough times, they are worth it! Bonds can be especially helpful in the years leading up to retirement, or in any situation where you need to sell assets within a portfolio for liquidity.
For example, as my daughter (age 11 now) gets closer to University, I’m allocating more of her RESP towards bonds. Eventually, I will move a portion of the RESP into cash/GICs to ensure that the cash will be there when tuition is due!
Here are more details on how and why asset allocation works.
7. Should you worry if your stocks don’t perform as well as the market? Why?
Most investors would benefit most by indexing their portfolio. It’s easy, require minimal research, and will beat most mutual funds out there over the long term due to the low cost of index ETFs. In fact, my wife’s RRSP and our children’s RESPs are 100% indexed. If market volatility (ie. risk) is a concern, then picking individual stocks (even dividend stocks) might not be the optimal path.
I have been fortunate in that my dividend portfolio has outperformed the Canadian index thus far since inception, but that’s not my goal. Since early retirement is on the table (possibly in my 40’s) my goal as a dividend investor is to build a growing passive income stream that is tax-efficient and relatively safe. Beating the market is a bonus!
That was a few answers to some common dividend investing questions. If you have any further questions, feel free to leave them in the comments, or send me an email through the contact form.
Happy Investing!If you would like to read more articles like this, you can sign up for my free weekly money tips newsletter below (we will never spam you).