Dividend stocks aren’t for everyone, experts say

The comfort of a stable and predictable income. (Photo: The Canadian Press)

Bob Lai, a 39-year-old product manager and blogger from Vancouver, owns an investment portfolio of 51 dividend-paying stocks and one exchange-traded fund (ETF).

Bob Lai started investing in his early twenties, before ETFs were widely available or popular. He started investing in mutual funds before moving on to individual stocks like those of Intact Financial Corporation (formerly known as ING) and Manulife Financial, which paid dividends and continued to do so after the financial crisis.

“(My partner and I) just thought it would be nice to have this stable dividend income. Living off those dividends would give us more flexibility rather than having to sell our capital. So that was the appeal.”

Dividends are generally paid quarterly and work as follows: For example, if you own 100 shares of Royal Bank of Canada and receive $1.20 per share, you will receive a deposit of $120 in your brokerage every February, May, August and November account, explains Bob Lai.

But while some investors rely on a dividend-paying stock investment strategy, this approach isn’t for everyone, experts warn.

Dividend payers are typically established companies with excess cash flow, so they start returning that cash flow to their shareholders, says Robb Engen, a paying financial planner at Boomer and Echo in Lethbridge, Alta.

These are often so-called “blue chip” companies such as Royal Bank, Enbridge, Telus and BCE.

While there’s nothing intrinsically wrong with investing in big blue-chip companies, Robb Engen believes that shouldn’t characterize the entire strategy for most people, and especially young people.

Instead, young Canadians should focus on growth, not income from their wallets.

“We want to expand our investment universe to include other stocks that don’t just pay dividends.”

loss of goodwill

Robb Engen points out that many people also don’t realize that a dividend payment comes from a company’s earnings and cash flow. So if we get a dividend of $1.20 per share, the value of this company will decrease by that amount because it paid that money.

“Dividend shareholders could do anything with that money. You could spend it. You could invest it in another business. So the value of the company just went down,” he explains.

“I think a lot of dividend investors think they’re seeing that dividend and they think they’re getting that return on top of capital appreciation, but capital appreciation gets diluted every time the company pays a dividend.”

For example, on growth, Robb Engen says that FP Canada’s forecast assumption guidelines show Canadian equities as a whole have an expected return of 6.3% before fees, US and international equities have an expected return of 6.6% before fees and equities from emerging markets have an expected return of 7.7% before fees.

So when you invest in a company like Shopify that doesn’t pay dividends, your return is tied to the company’s appreciation. The investment in the company is worth more because the share price has risen, explains Robb Engen.

For a dividend stock like Enbridge, for example, the company doesn’t rely as much on growth.

“They make money from their pipelines, pay their expenses and return the rest of the profits to their shareholders as dividends. So if you’re receiving a 6% dividend, don’t expect the stock price to go up,” he notes.

The company that pays dividends doesn’t invest as much in its growth through acquisitions or other avenues, he adds. These are two different styles of running a business.

“Nothing comes for free. You can’t get the 6% dividend Enbridge promised, on top of the 6% growth you could get from a company that doesn’t pay a dividend.

The comfort of a stable and predictable income

However, it can be beneficial to focus on stocks that pay dividends when you feel confident of receiving a quarterly dividend and thereby protecting your investment.

“If there’s a behavioral reason to help stay focused and prevent panic and selling when the market falls, then I think it could be a sensible strategy.” It just won’t be the most efficient way to build wealth over time if you want to invest in the broader market rather than focus on dividend payers,” he notes.

Instead, Robb Engen advises clients to keep costs low and diversify broadly, rather than focusing on just one type of stock.

For example, for the average Canadian, like Robb Engen, Bob Lai prefers index investing with Vanguard ETFs or iShares and thinks it’s a good approach because you can just leave your investments and don’t have to think about it.

“But if, out of personal preference, you want that level of convenience in the form of stable, predictable income, I think dividend investing is great because you’re seeing the numbers and seeing the earnings on a regular basis,” says Bob Lai.

In Bob Lai’s case, he projects dividends of about $50,000 to $60,000 a year through 2025 from the $1.5 million he has invested. Since he, his partner, and their two children have lived on $50,000 to $55,000 for the past seven to eight years, he reckons they could be living on those dividends.

Still, Bob Lai loves his job and has no intention of quitting. If he ever had to stop working full-time, he would probably supplement his income with a part-time job.

“I’m in no hurry to hand in a letter of resignation and relax on the beach every day. That’s not the plan.”

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