August 3, 2010, 5:00 am

To Dividend or Not to Dividend

by: The Financial Blogger    Category: Canadian Dividend Stocks,Investing Ideas,Investment, Market and Risk
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I have an important dilemma to debate right now. When it’s time to talk about investing, I have 2 convictions:

– Index investing is probably one of the best way to make money without worrying too much about the trades to make.

– Dividend investing is also a great way to build a strong portfolio that generates income.

And yet the 2 strategies are not serving the same purpose:

– Index investing is looking forward to produce long term growth.

– Dividend investing is looking to produce a steady flow of income right now and benefit from an eventual growth.

But what really bugs me in this dilemma is not the purpose of investing but the results you get when you compare the 2 strategies (beware, this is going to be ugly!):

In order to make a comparison between index investing and dividend investing, I have taken one of the best index funds vs one of the best dividend funds. How did I choose them? I looked at established mutual fund companies and took funds that have more than 10 years history to be able to make a real comparison. Then, I took one of the best yields for both of them (looking at 3, 5 and 10 year annualized yields). So I have the Altamira Canadian Index fund Vs the RBC Dividend fund. Since the Altamira fund was created in 1998, I had to take this point to make the comparison. So here we go (click on image to enlarge)


So there are 2 things that you can see while comparing index investing vs dividend investing:

#1 Over the past 11 years, investing in dividends shows a better return.

#2 When you look at the annualized rate year by year, you can see that the index funds will out beat the dividend fund easily in periods of growth but drop rapidly and lose the advantage as soon as it hits a market drop.

So, after looking at those two graphs and taking a good sip of coffee, I still wonder if it really worth it to suffer bigger fluctuations and ending-up with a smaller yield with an index.

On the other side, there are a few considerations to take for the upcoming year if you think of buying a dividend fund versus dividend stocks:

#1 Growth is unlikely to come from Canadian banks. They will do fine but I don’t see them increasing their profits like Apple!

#2 If you buy dividends funds, they usually include bonds and preferred shares. Therefore, their value will drop upon increases in interest rates.

#3 If we are going to enter another period of economic growth (most major companies in the US show strong financial results), chances are that index investing will be a winner for the upcoming years.

#4 We are taking 11 years to make the comparison where we had 2 majors economic crisis. If we take the same 11 years period in a few years, we would start our calculation after the techno bubble and chances are that the same graph will show different numbers.

So I’m still not convinced which one is best for a long term project…

What about you? Dividend investor or Index investor?

and if you want to learn more about dividend investing, I suggest you go look at our new blog; The Dividend Guy Blog.

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Comments

I understand 100% really, I often have the same debate with myself. I’m not yet convinced either way, I really think both can be good solutions but maybe indexing is a little easier. The fact is that both can do well, it all depends on the circumstances. So are you going all in with a dividend portfolio?

I’m a bit of both. Indexing for the RSP but dividend for the TFSA. No real significant reason why; I like both styles.

Why choose? Why not do both? Index investing in RRSPs, dividend (stock) investing outside RRSPs and registered accounts?

by: The Financial Blogger | August 3rd, 2010 (12:19 pm)

@IS
I don’t know yet… I am definitely considering the dividend portfolio for my next Smith Manoeuvre strategy…

@TinyPotato,
do you have an account that outperforms the other or they are showing about the same yield?

@Financial Cents,
I’d do the opposite since index investing will generates capital gains (at the moment of the sale only) while dividend generates taxable income each year….

I don’t understand why so many stocks don’t issue dividends. To me, dividends are safety because they indicate that management is actually doing what they’re supposed to = providing the owners with returns. CEOs are under pressure to keep the business performing because they need to pay the owners. A good thing.

Dividends are also price stabilizers. A dividend stock maintains its price by virtue of the payout. A spec stock with no dividends is just held aloft by hopes, so when the hopes fade a little so does the stock price.

I am not sure the graph you have represent holding a dividend aristocrat where the dividends are re-invested over 10 years. Let’s say you take BMO and you buy enough to DRIP 1 or 2 shares. The stock price may not grow significantly, but the DRIP and raise in dividends will make up for that.

Of all the graphs that compare ROI and performance, I have never seen a graph showing the difference between the performance if you had re-invested the dividends or not from a true scenario. I am not even sure if it takes into account the dividends paid. All I am saying is that graphs can be very misleading if you don’t know the parameters they are built from. That’s why I always generate my own graphs and table when I look at dividends and compound growth.

I think dividends (re-invested for compound growth) beet an index over 20+ years. Not only do the dividend aristocrat make up for a large part of the indexes in general, the index doesn’t have re-invested dividends. If you don’t re-invest the dividends, that’s another story.

You can do anything with numbers! 🙂

by: The Financial Blogger | August 3rd, 2010 (4:44 pm)

@ Passive Income Earner
Very good point!

I actually tend to think that profit reinvesting are accounted with mutual funds but I’m not 100%. If it’s the case, the dividends would definitely pay more than any index fund…. quite surprising!

@TFB – My dividend growth is just started out so I can’t really compare it to my index portfolio just yet. Also, my dividend portfolio is likely going to be canadian and XDV for the first while while my RSP has US and International components. So not really a fair comparison.

Hopefully over the long term they both do well.

This makes me thinkg, a CDZ vs. XIU comparison might be an interesting thing to look at.

@ TinyPotato
hum… interesting.

In the meantime, I’m doing a XDV review on The Dividend Guy Blog tomorrow! Be sure to come and comment!

http://www.thedividendguyblog.com

Cheers,

Mike.

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Your point about the recent lower interest rate environment and 2 economic crises during the last 10 years create an unual economic scenario. Since the future is unknowable and past performance does not determine future results I’d suggest a diverse asset allocation across a variety of asset classes including international & domestic equities, bonds, reits all invested in index funds.
If you are discussing just these 2 funds, I’d invest in both. Take your equity investment dollars and divide them up.

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