At the beginning of the year, I had set 3 main investing goals (you can read about them here):
#1 Buying a consumer stock (I picked another techno stock instead with Apple)
#2 Dripping most of my stocks (not done yet, I’m procrastinating!)
#3 Buying an index ETF (most probably an ETF tracking the S&P 500)
Why a Dividend Investor Would Switch to Index Investing?
The main purpose of dividend investing is obviously to select the stocks you think will both outperform the market and pay some healthy dividends at the same time. The power of dividend growth over time should guarantee a nice and comfy nest egg too.
So why would I invest a part of my money into indexes? What’s the point of adding ETFs to a 100% dividend stock portfolio? The reason is simple; I want additional growth while not spending too much time working on my portfolio. I will still buy dividend stocks and continue with my core strategy, but will add some ETFs to my asset allocation; here’s why.
Reason #1: Instant Diversification
When I look at my current asset allocation, I notice that I’m heavily invested in three sectors: financials (BNS, NA), technology (INTC, AAPL, STX and Telus is on the borderline of being techno) and resources (CVX, HSE, VNP). I added some stability with JNJ and KO but still, that only makes 4 sectors for my whole portfolio with a heavy concentration in techno stocks (there is a reason for this and you can read it here).
By investing 10% of my portfolio into an ETF tracking the S&P500, I’m adding immediate diversification. will cover several sectors at the same time and ensure some growth during a bull market. I can then concentrate my dividend stocks into specific sectors without having to worry about my asset allocation being unbalanced.
Reason #2: Avoid the Impact of the Fiscal Cliff
We are still not 100% sure about what is going to happen with the dividend taxation model after the US government resolves its fiscal cliff. I don’t have a crystal ball but I expect an increase in taxes. The US government is stuck with a debt problem and it’s the lowest taxed industrial country. This seems like an easy solution to resolve an important problem.
What would be the companies’ and investors’ reactions once their dividends are amputated? We can’t really tell. History has shown us that tax breaks brought more dividend stocks to the market but it doesn’t mean these companies will withdraw their payouts once additional taxes are levied.
The best way to play safe is to add some non-dividend paying stocks to the equation. By adding an index, I ensure I hold companies doing others things to generate wealth for investors than paying dividends. They will invest in R&D, participate in mergers and acquisitions, market new products, buy back shares, etc.
Reason #3: Seek Growth in a Bull Market
The S&P 500 was up 16% in 2012. I expect 2013 to be a similar year as the problems are known (government debts, slow growth, BRICK slowdown) and businesses will continue to post solid results. Since the market is still undervalued, it would normal to see it jump by 10%
The problem is dividend stocks have been the teacher’s pet for a while now. With low yielding bonds and stock volatility, some dividend stocks grew fast and are how valued with a premium (over 15-16 P/E ratio). Non-dividend paying stocks have been ignored and undervalued. This situation may switch rapidly due to the fiscal cliff and pure growth stocks could steal the show in 2013. If this happens, it will be hard to beat the market with only dividend stocks. They may pay a nice dividend and I feel that pure growth will also be necessary. I don’t want to miss the bull market and think that investing 10% of my portfolio in an index ETF will be a good move.
Reason #4: One Position I won’t have to Reevaluate
Managing a stock portfolio is not only about buying the right stock at the right time. You have to follow each of your stocks over time to make sure the reason why you have bought them in the first place is still valid. This is why I reevaluate each stock once a year and follow their quarterly releases to ensure growth and cash flow are still generated.
Buying an ETF index is also buying some free time. You don’t have to reevaluate your position on a quarterly basis. You basically just have to rebalance your portfolio once a year but that can be done with a simple trade and not through a deeper financial analysis. I don’t want to go with a coach potato investment approach as I like reading financial statements and feel I can build a very solid dividend payout over time. However, it doesn’t mean I can’t save a few hours by buying an ETF!
Reason #5 It’s a Nice Way To Manage My Liquidity
Instead of parking a part of my money in a money market fund earning 1%, I would rather invest in the stock market right away. It’s more volatile but the money is still accessible. If I want to sell my ETF to buy a good dividend stock, I will always have this possibility. Chances are that if a specific security drops significantly and becomes a buying opportunity, the market as a whole will be down too but will still be less affected. Therefore, I would sell my ETF down by 4% and to buy a stock that dropped by 10% or more. This would be a great deal.
On the other hand, if I wait 6 months or a year to buy another dividend stock, I am almost assured to avoid leaving money on the table by buying an ETF. Leaving my cash in a money market fund that doesn’t even make up for inflation is a tragedy!
Final Thoughts on ETF Investing
I should be making my move in the upcoming weeks as the money is currently sitting in cash in my account (and I literally hate when this happens!). I think I will be making a better move by investing in a diversified ETF covering the S&P500. My goal is not to have a dividend concentrated ETF as I preferto manage those stocks on my own. By adding a wider spread ETF, I think I’m building a stronger portfolio.
Do you invest in ETFs? How’s your asset allocation for 2013?
I agree with your thesis on the need for diversification but I would suggest that a US market index has more upside than a Canadian one. The US economy is slowly but surely coming to life and at this point has much more upside than Canada. We have a slowing housing sector, a debt burdened population, depressed commodity pricing and gridlock on pipeline expansion.
All of my retirement portfolio is in ETFs. I’m a bit more conservative there and the diversification let me sleep well at night. My after tax account has all my dividend stocks because I’m using part of that to pay our monthly expense now that I’m retired.
Outside of a retirement account, I wouldn’t bother with an ETF. But then again, I’m intensely focuses on increasing my passive income streams to achieve financial independence as soon as possible. If I was going to diversify, I would look into bonds or asset class.
My dividend stocks are beginning to become increasingly diversified over all 10 S&P500 sectors as my invested capital grows, so buying an index ETF, wouldn’t help me out too much with diversity.
Nice call. I own a bunch of VTI for the same reasons and more.
I won’t sell my stocks though 🙂
Mark
I don’t have ETFs just yet. I would buy some just for bonds though. My RRSP is mostly in indexed mutual funds due to the company contribution plan so I am already plenty of non-dividend investment already. Although, I would gladly switch them because I prefer the performance of my dividend accounts. 🙂
I have been reading that is better to have equal weghted equity ETF that 60% in big Cap 40 % small cap stocks for growth. What do you think ? I believe you must check ETF keeps this ratio when ETF is rebalanced.