What is your opinion of dividend exchange-traded funds? I see that your model portfolio is composed primarily of individual dividend stocks, but don’t dividend ETFs give you the same benefits with less effort?
I have nothing against dividend ETFs. In fact, I own several myself. They are a quick and easy way to improve the diversification of a stock portfolio.
Nor am I opposed to going with a straight ETF portfolio if that’s what works for you. After all, not everyone has the time or expertise to monitor a collection of individual companies.
In addition to enhancing diversification, ETFs offer emotional and behavioural benefits as well. If you own individual shares of a company that runs into trouble, you’ll probably stress over whether you should hang on or sell. But if that same company accounts for a relatively small weight in a well-diversified ETF, you’ll be more likely to take the loss in stride. It’s not like you have the option to sell the stock anyway, unless you want to dump the entire ETF, which would be silly.
That said, ETFs aren’t perfect. Compared with owning individual stocks, ETFs have two main drawbacks: they charge continuing fees, and some dividend ETFs are concentrated in certain sectors, which undercuts their diversification value. But these are not deal-breakers.
Below are three dividend ETFs that offer the best of both worlds: a relatively low management-expense ratio and decent diversification. There are many other worthy dividend ETFs out there, so consider this a starting point for further research. And remember that having the discipline to hold through good times and bad is just as important – if not more so – than which dividend ETF you choose.
iShares Core MSCI Canadian Quality Dividend Index ETF
Ticker: XDIV-T
Holdings: 21
MER: 0.11 per cent
*Yield: 4.1 per cent
**5-yr ann. return: 17.5 per cent
If you can get past the relatively small number of holdings, XDIV checks a lot of boxes. The low MER is hard to beat, the five-year return is impressive, and the ETF’s 27-per-cent exposure to energy will appeal to investors who are bullish on companies such as Suncor Energy Inc. SU-T and Tourmaline Oil Corp. TOU-T, both of which are included in the portfolio. Banks, insurers and utilities also figure prominently, but the presence of BCE Inc. BCE-T is a bit of a head-scratcher, as it recently cut its dividend by more than half. Fortunately, it accounts for less than 1 per cent of the portfolio.
BMO Canadian Dividend ETF
Ticker: ZDV-T
Holdings: 52
MER: 0.39 per cent
Yield: 3.5 per cent
5-yr. ann. return: 15.6 per cent
With more than twice as many holdings, ZDV offers better diversification than XDIV. But its total return has lagged XDIV’s, reflecting differences in portfolio composition and the additional drag of ZDV’s higher MER. Still, ZDV managed to beat the S&P/TSX Composite Index’s total annualized return of 14.9 per cent over the past five years. Disclosure: I own ZDV personally, one reason being that my discount broker lets me buy and sell the units (and those of several dozen other ETFs) without paying commissions. This is a key benefit for investors who reinvest their dividends manually to maximize compound growth.
Vanguard FTSE Canadian High Dividend Yield Index ETF
Ticker: VDY-T
Holdings: 61
MER: 0.22 per cent
Yield: 4.4 per cent
5-yr. ann. return: 17.2 per cent
VDY has an attractive MER and has put up solid returns. But be aware that the ETF is heavy on financials, with Big Five banks accounting for roughly 40 per cent of the portfolio (compared with less than 20 per cent for both ZDV and XDIV). Throw in a few insurers, asset managers and smaller banks, and VDY’s financial weighting rises to 53 per cent. That’s fine as long as financials continue to perform well, but it could be problematic if the economy slides into a recession and loan losses rise. Still, Canadian banks have been excellent performers over the long run.
Closing thoughts
ETFs are supposed to make investing easier, not harder, so don’t overthink your choices. If you’re having trouble deciding which ETF to buy, you could always invest in two or three to give your portfolio even greater diversification. Whether you reinvest your dividends manually or make the process automatic with a dividend-reinvestment plan, using your cash to buy more shares is one of the secrets to long-term investing success.
*Yield was calculated by dividing total distributions over the previous 12 months by the share price as of noon on Friday.
**Five-year annualized return is for the period ended May 31 and assumes all distributions were reinvested in additional units.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.