A couple of weeks ago, I asked you why you think you can beat professionals? This led to an interesting conversation about the difference between beating the market and reaching your goals. I think the most important thing is to reach your financial goals. It’s like registering for a run; when you register for a 10K, you don’t mind if you win the run or not; you focus on your own running objective. As long as you reach that goal, your run is a success. This is also a good mentality to apply when investing.
After writing this article, I received an email from a reader asking the question about the difference between buying SPY (Spider S&P 500 ETF index) yielding nearly 2% and building a dividend growth stock portfolio:
More often than not, I choose not to buy individual stocks when I compare their yield to SPY, which is a core holding in my account. Can you perhaps do a write-up of SPY? It has all the same advantages a good dividend stock has. It has dividend growth, it has a reasonable yield, dividends reinvested in SPY will have the same snowball effect. But, it has a KEY advantage that individual stocks do not — diversification.
So how can I determine if an individual stock is a better buy than SPY? When is the decision to to buy an individual stock for its dividend better than my default position of “keep it in SPY”? What return should an individual stock give me for the risk of abandoning SPY’s diversification? What risk premium?
I found his question quite interesting as it positioned a global well-diversified and dividend paying investment vehicle trading with very little effort Vs a handpicked dividend growth stock portfolio requiring continuous management. Let’s dig deeper to see what both strategies have to offer…
SPY is Not a Dividend Growth Portfolio
First, let’s be honest, SPY is not a dividend growth portfolio. This is not its function, regardless if the members of the S&P 500 pay enough dividends to have a yield around 2%. When you look at its past 10 year dividend history payment, you understand better why SPY can’t really replace a dividend growth portfolio:
As you can see, dividend payments are quite hectic. This is normal as within the group of the 500 biggest companies, you will have a little bit of everything:
Strong growth companies not paying dividend
Classic dividend growth companies
Companies going through troubles and cutting their dividend
Etc.
Being a “big company” is not a gauge of success and it is also far from an indication you will see your dividend payments growing. It becomes obvious when you compare the dividend growth in % over the past 10 years compared to a classic dividend growth company such as Johnson & Johnson (JNJ):
JNJ dividend payments increased steadily year after year and offer double the dividend growth payment than SPY over this period.
Besides the dividend growth test fail, there are many other reasons why I’m not a big fan in investing in SPY as a dividend growth investor:
It doesn’t follow my dividend growth investing philosophy.
Dividend payments are hectic.
SPY includes too many “bad companies” I wouldn’t pick.
The overall market is not what I want to buy.
In the end, there are very limited similarities between a dividend growth portfolio and SPY. The dividend yield may confuse investors, but don’t fall in the trap; if you are looking for a dividend growth investing vehicle, SPY is not the one.
What About a Dividend ETF Then?
One question leading to another, I wanted to finish this article by with a comparison of a dividend growth ETF vs a handpicked dividend growth portfolio. I’m all about efficiency in life and if I could spend a big 3 minutes to initiate a transaction in a dividend growth ETF and forget about my investing strategy for the rest of my life, I would gain several hours each year to do other things than manage my portfolio and reading about the stock market. Let’s take the Vanguard Appreciation ETF (VIG) dividend growth and compare it to JNJ again:
I’ve taken the 5 year view as there were unrealistic increases back in 2007 (dividends doubled within 3 quarters) and it wasn’t giving a good comparable. Still, even by using the 5 year dividend growth period, we can see how JNJ shows a pure and systematic dividend increase while the VIG payment increase is quite hectic. Nonetheless, VIG dividend payment growth is double that of JNJ, one of the most appreciated dividend growth companies on the market. As far as stock price goes, we are at the same pace:
In other words; while VIG dividend growth is hectic, any investors would have been better with the ETF than with JNJ. However, it is unfair to compare a diversified ETF with a single company. This is why I did the exercise with my top 10 dividend growth stocks as a portfolio vs the same ETF:
Unfortunately, I can’t perfectly compared this growth portfolio with the VIG as not all data can be used in 2011 and DIS decided to pay dividends twice per year instead of once a year explaining the virtual drop on the graph (but it will go back up once the year ends as a second dividend payment will be issue.
One thing you can see is that the dividend payment for most companies is steadily increasing without any big jump (besides BLK in 2011). However, I can compare the price evolution of the portfolio:
The average stock price gain is 114.65%, more than double the VIG.
Conclusion
The conclusion of using ETFs vs handpicked dividend stocks is similar to the conclusion of my previous post:
First and foremost; as long as you reach your financial goals – you probably have the right method,
Second; market index ETFs such as SPY are too wide to represent a dividend growth investing strategy. They are good products, but not for dividend investors,
Third; similar to market index ETFs, dividend ETFs often includes a too wide number of companies. Handpicked dividend growth stocks, if done wisely, can beat such products.
In order to make sure my investment strategy works, I use the VIG as a benchmark. So far, I’m very happy with my results and they justify the efforts I make to manage my portfolio. I think dividend ETFs can help you achieve your financial goals as well if you are not interested in taking the time to manage your own portfolio but still wish to invest in a vehicle paying dividends. Then again; there are no right answers besides the one that makes you comfortable with your financial objectives!
I completely agree with your closing statement Mike. Each investors style needs to match their own objectives and personality. I run a half (dividend growth) and half (deep value) portfolio. It wouldn’t work for everyone, but it works great for my family and our objectives. In the next 2 or 3 years, as our lifestyle changes, we will be transitioning to a 70% passive index (likely ETFs) and 30% individual stock…..portfolio. It will just work better. Hopefully the readers won’t abandon my blog…..but either way…..the transition will be the right thing for our family.
I enjoy your content and RV posts. Wishing you a great weekend!
-Bryan
Hey Bryan,
Personally, I find it very interesting to read blog about other investing strategy than mine. It gives me another perspective and this is how you evolve as a human being 🙂
Keep it up!
Mike.
Great article, Mike. And a great summary presenting the comparisons and why one would want to choose vs. the other. My biggest problem with going with ETFs is that I end up with the bad with the good. The diversification aspect takes care of the problems and mitigates the risks, but I’d rather not be invested in some of these companies. Having said that – using a broad ETF such as SPY is probably the best way to invest for most ppl.
Thanks for breaking it down and sharing another great post
R2R
Hello R2R,
The reason of holding the good and the bad comes around often when the EFT discussion arises. This is also the main reason why I prefer creating my own portfolio instead of holding “a little bit of everything”.
Cheers,
Mike.
Great article, dividend growth can be a concern for ETF’s, especially when you can’t control which dividend stocks is being held in ETF. I think having a combination of ETF’s and individual dividend stocks is the best way to go. You can essentially create your own mini dividend ETF’s by owning a group of dividend stocks.
Hey Tawcan,
I’ve seen many portfolio including a mix of ETFs and dividend growth stocks. It seems to work very well, especially for an investors seeking for more diversification than equity.
Cheers,
Mike.
Interesting post.
I feel the major flaw with this method is that you choose your favorite stocks of now and think you would have made the same list 10 years back in time.
Now if we have another look in 10 years from now and the same is still true that would make a great post.
Hello Mr. T,
This is always the problem when you try to make comparison; you need to prepare them 5-10 years BEFORE to make it realistic. At least, our portfolios at Dividend Stocks Rock were created in 2013 and we track their performance against ETF dividend index since then. In a few years from now, we will have something very interesting to present in term of comparison.
Cheers,
Mike
Nice comparisons, but you said it was only over 5 yer period? I would like to see what your portfolio would look like vs. ETF over 20 year period. I tend to say that a handpicked portfolio would do better at least due to low or no fees, no redemption, and other stuff the ETF is exposed to, but I may be wrong. I guess this can be compared by looking at the dividend growth of the entire portfolio not just JNJ and calculate the portfolio YOC to compare with the ETF. I might do that on my own portfolio to see if my mix is better to that of the ETF.
Hello Martin,
I can’t wait to be able to make the “real” comparison ETF vs handpicked dividend growth stocks for 20 years… I’ll be able to do it in 15 years! hahaha!
More seriously, I believe my picks will be better than an index. So far, so good, but there is a long way to go!
Cheers,
Mike
We can create at least a simulated model of that. Maybe next week I will try to create on my own portfolio. It will not be an exact and real life model (as I will not be adding additions to the portfolio for which I do not have enough time), but I think it may show how we might perform now just reinvesting dividends. I think, your handpicks will end up better than the ETF. I also believe in it.
We can, but several investors could tell us we cherry picked our stocks as we couldn’t be 100% sure to have picked those companies 15 years ago… that’s the problem with simulations. At least, it will give us a good idea of how both the ETF and the handpicked portfolio did! Let me know if you do the maths 🙂
Cheers,
Mike
With an ETF, you own a little bit of a lot of businesses (even VIG…). When you select stocks individually, you get to own only great businesses, and you can choose to buy them only when they are trading at above their average yields (or below average P/E ratio, etc.). Additionally, you get to avoid ETF management fees. If you take a disciplined approach, I think individual stock selection is preferable for most people.
Hello Ben,
I’m not ready to say that individual stocks are better for most people. There are tons of investors who start their portfolio because they don’t trust financial advisors but it doesn’t mean they know a lot about investing. Picking individual stocks for such investors could be disastrous. You will not hit homeruns with ETFs, but you will not make bad moves either. It all depends on which kind of investor you are. Not everybody will want to spend hours managing their portfolio. Rebalancing ETFs is easy and takes very little time.
Cheers,
Mike.