PETER DOLEZAL: The benefits of dividend investing

Investors and their advisors usually gravitate toward one of three types of equity investments.

Investors and their advisors usually gravitate toward one of three types of equity investments: value stocks; growth stocks; or dividend-paying stocks. The first two options require a significant amount of research, judgment, ongoing monitoring and to a significant extent, timing of markets. Of the three choices, selecting dividend-paying equities is by far the easiest process and one that is virtually certain to please over the long term.

Consider this. Since 1940, approximately 40 per cent of the 10.6 per cent total annual returns of  the S&P/TSX Composite Index have come from the reinvested and compounding value of the dividends received.

Even more dramatic are the relative results of various elements of the TSX Composite Index over the 25 years ending June, 2011 — as researched by RBC Capital Markets.

During this 25-year period, the TSX Composite Index delivered a very respectable average annual total return of 6.9 per cent — a result many investors would be pleased to achieve — until they consider the following breakdown of the performance of various components of the Index during that same period:

 

Average Annual Total Returns — 1986 to 2011

 

S&P/TSX Composite Index    6.9%

 

Non-Dividend Payers        1.6%

 

Dividend Cutters        2.9%

 

Dividend Payers         10.5%

 

Dividend Growers        12.2%

 

Clearly, had the investor chosen only the dividend-paying component of the Index during this 25-year period, he would have outperformed the total index by an average 52 per cent annually — and by even more had he chosen only the dividend-growers.

Since the astute investor diversifies geographically beyond Canada, he can reasonably rely on this same relative performance trend of dividend-paying components of not only Canadian, but also U.S. and international indexes.

It is this compelling long-term evidence that points to the value of dividend investing as the most prudent and least-risky means of investing in equities — no matter which market is chosen.

Many equity mutual funds focus on this dividend-paying sector. However, a significant portion of the performance advantage is eroded by the high mutual fund fees, on average in Canada about 2.4 per cent annually. The same performance advantage can be captured by low-cost Index or Exchange-Traded Funds (ETFs) at a small fraction of the cost charged by mutual funds — thereby preserving for the prudent investor most of the performance advantage.

What easier way to limit equity investment risk, while delivering reliable annual income and solid long-term returns, than to exclusively select dividend-paying and dividend-growing investments?

This analysis is not meant to replace the logic and need for a suitable fixed-income component in every portfolio. However, it does provide compelling food for thought for the equity component of a carefully-structured portfolio.

Contact Panorama Rec Centre to register for Peter’s Elder College Spring session: Financial & Investment Planning for Retirees & Near-Retirees  (Wednesdays, March 18 to April 15).