Last week, I wrote an article in reaction to Rob Carrick’s praise for ETF investing. I showed in this article that I was able to beat ETF indexing with dividend growth stocks on a constant basis. Am I a genius? Am I ready to become the next Warren Buffett simply because I beat the market for a few years in a row? I don’t think so. In fact, I think I’m far from this point. The most important factor explaining my performances has nothing to do with my investing abilities or knowledge. The most important reason why I beat ETF investing is because I stick to my investment strategy. There are various reasons why a single investor can hope to beat the Street Pros. There are also many factors helping dividend growth investors to beat ETFs. Here are my top 3:
01 You don’t get to decide
I guess this is the reason why so many people decide to pick their own stocks to build their portfolio: they like to decide and to remain in control. Beyond the taste of independence DYI investing can give you, it may also help you to beat several ETFs. The problem with ETF investing is that stocks are picked for you based on metrics or a philosophy that may not be entirely yours. In other words; you are not investing according to your strategy but according to someone else’s.
A Canadian investor could be tempted to invest in well-known dividend paying ETFs instead of building his own portfolio. After all, you save time, you save fees and you get a “professional diversification” with a single holding.
Let’s take a look at 2 Canadian dividend paying ETFs to see what is inside the hood. Since I’m a big fan of BlackRock (BLK), I’ve selected the CDZ (Canadian Dividend Aristocrats Index ETF) and the VIG (Canadian Select Dividend Index ETF). Many investors would be tempted to invest in the CDZ as it has the label “aristocrats” in it. After all, we are talking about companies showing stellar dividend growth profile. Here what is looks like:
I don’t know about you, but I would feel uncomfortable having 20% invested in the highly volatile energy sector. Plus, there are companies in the top 10 that are screaming “sell” in my opinion.
Corus Entertainment (CJR.B.TO) is not going into the right direction and I would never hold this company in my portfolio at the moment. Advertising revenue is going away from traditional media such as radio, newspaper and TV, and gets concentrated toward internet marketing. Why? Simply because internet marketing provides stats, metrics and funnels no other type of advertising can. With internet marketing, you can target exactly your “perfect customer” and talk to him. Even better, you will know how he will answer to your ads. Where is your perfect customer when he switches between a hockey game and the Disney Channel?
Now, if we look at the VIG, we don’t get a better picture…
In this case, we have a different problem. The top 10 is filled with strong companies I would like to have in my portfolio… but they are almost all coming from one sector! Having 65% of your portfolio invested in a single sector is just plain stupid.
Therefore, in both cases, a dividend growth investor can easily follow his investing process to the dot and build a stronger portfolio.
02 Not really active management
In today’s market, some situations change rapidly. A dominant player in a strong niche could rapidly see its revenue evaporating like it’s in a sauna. Talk to any BlackBerry shareholders if you want to have an idea of what it feels.
As I highlighted in my first point, some holdings should not be part of an ETF. Corus is the perfect example as everything was doing well a few years ago. The company was solid and delivered strong returns during the last market crisis. The stock even outperformed the market between 2012 and 2014:
Source: Ycharts
However, the landscape isn’t the same one since then. While a dividend growth investor could have seen this coming by reading Corus quarterly earnings and looking over his portfolio, the CDZ just kept CJR in its portfolio as there was nothing. Today, the stock is showing a 13+% and there is probably other bad news coming our way. What’s happening with the ETF? Nothing. It stays the course.
03 There are lots more than yield and dividend growth metrics
By definition, classic ETFs will track a specific group of stocks. You can buy an ETF tracking Canadian aristocrats, the energy sector or the market as a whole. From what I can see, most dividend focused ETFs are built based on a name (aristocrats), yield or dividend growth.
It makes sense to create a basket with such metrics, but I would add a little bit more human thinking in the process. Then again, Corus does qualify as a dividend aristocrat and it is part of the ETF since its job is to track all “aristocrats”.
I also use a set of metrics to start my research. However, metrics only tell us one thing about the company’s past. It doesn’t tell us much about what is coming. You need to look at graphs to see trends and you need to read quarterly earnings and annual reports to understand where the company wants to go. Unfortunately, most ETFs don’t read. If you want to solve this problem, you need to find actively managed ETFs… which becomes not too far from a mutual funds to some extent.
This point also highlights the fact that you need to know what you are doing even if you invest in ETFs. The moment you stop investing in ETFs tracking major indexes and you look for specific ones, you enter in a world of infinite possibilities.
Final Thought
While I just painted a pretty dark landscape for ETF investors, I still think it is a very good way to invest one’s money. ETFs offer a wide diversification and it is the best vehicle if you want a simple way to invest in the stock market. You just have to buy something that track the S&P 500, the TSX and the MCSI and you will do just fine. Things get messier if you try to track specific sectors or type of investments. This is why I will continue my journey with dividend growth investing. I can’t wait to see what will happen when the market crashes…
Dividend Investing is awesome and can outperform some ETF. But when you are low in money to invest ETF is awesome for the diversification and for the no fee buy.
If I was starting a portfolio with less than a few thousands, I would definitely pick a few ETFs instead! There is no point of holding only 2-3 stocks in your portfolio.
Great points over there. Personaly my main motivstion is to stay in control. I like to know ompanies that I own. To feel like a real shareholder 🙂 Im not aiming to outperform the market. Im aiming for good purchases 🙂
There is definitely a “fun” holding companies and following them. There is no such fun with ETF!
Not too far from my own thoughts – the best part for me is being able to tailor my portfolio exactly as it suits me, and being able to exclude companies that I’d be ‘forced’ to invest in through the ETF. Being disciplined and stick to your own strategy is a must though!