There is currently a debate raging online between die hard dividend investors and total return investors. I’m sure this debate has been raging since the dawn of time and will continue indefinitely. There is probably no end in sight but let’s dive in anyways.
For those not initiated in the debate, let me provide some clarity and explain why dividend and total return investors are both equally right and wrong.
Dividend Investors
Before we dive into the debate, some background is necessary.
For starters, a dividend is a portion of a company’s earnings that are distributed to its shareholders on a regular basis, usually quarterly in the form of a cash (or a dividend).
A dividend investor is someone who specifically focuses on investing in income-generating assets, such as stocks or funds, with the primary goal of receiving regular reoccurring dividend payments. Dividend investors seek out companies that have a history of paying consistent dividends and/or that have the potential to increase their dividend payments over time. These companies are often referred to as Dividend Kings or Aristocrats.
The goal of dividend investing is to build a portfolio that provides a steady stream of passive income, in addition to any potential capital appreciation, though regular cash generation is usually the primary motivation, particularly as one gets closer to retirement, early or otherwise.
Total Return Investors
A total return investor is an investor that aims to generate returns from primarily capital appreciation (increase in the value of investments held) associated with their investment portfolio. This approach focuses primarily on maximizing overall returns from capital gains rather than income generation, though any dividends are of course welcome (usually).
Total return investors often focus on investing in companies that don’t pay a dividend and rather re-invest profits back into the company. Though of course, companies like Facebook (otherwise known as Meta), historically non-dividend payers, can and in fact do sometimes switch courses and start to issue regular dividends.
With that said, total return investors often consider all aspects of their investments, including potential price appreciation and income generation, to achieve their financial goals.
So Dividend Daddy, where do you stand?
I hate to break it to you, but if you’re a dividend investor, you’re wrong. Yes, you heard me right. Dividend Daddy, the Daddy of all things Dividends, is saying that dividend investors are wrong.
At the same time, if you’re a total return investor, you’re wrong too.
But, you’re probably asking yourself, “But Dividend Daddy, how can both investors be wrong”? Well, it’s because both can be wrong but right at the same time!
Don’t cancel me. Let me explain.
I’m a Hybrid Investor
Before we get into the debate between dividend and hybrid investing strategies and why I think both are wrong and right, a little background is necessary.
For starters, I’m a hybrid investor.
As a Canadian, I invest in individual dividend paying stocks on the Toronto Stock Exchange (TSX). Why? Given the relatively small size of the Canadian economy within the world, and the oligopolistic nature of our economy, it’s easy to replicate the stock market by buying one or more publicly listed companies from the financial, telecomm, energy, and transportation sectors for example.
By doing so, you effectively purchase the index and can often be rewarded with higher returns, especially if dividends are DRIPPED (Dividend Reinvestment Plan) and/or reinvested (your results may vary).
So, pick a big bank say $RY (Royal Bank of Canada), pick a telecommunications provider, many like $T (Telus), an energy powerhouse like $ENB (Enbridge) or $SU (Suncor) and a railway like $CNR (Canadian National Railway). See what I mean?
Or just simply pick an index fund that tracks the the performance of the S&P/TSX 60 Index, net of expenses, like $XIU, otherwise known as the iShares S&P/TSX 60 Index ETF. The Top 10 holdings of $XIU are listed below. You could pick all 10 of the individual stocks below or pick one or more from each sector.
However, outside Canada, selecting individual stocks (dividend paying or otherwise) becomes tricky if not downright impossible given the overwhelming number of stocks in the U.S. alone, not including the world outside of North America.
So while I do own some individual dividend paying American stocks such as Coca-Cola ($KO) and Altria ($MO), most of my U.S stock investing is focused on the exchange traded fund known as Vanguard Total Stock Market Index Fund ETF ($VTI) for returns in U.S. dollars and iShares Core MSCI All Country World ex Canada Index ETF ($XAW) for returns in Canadian dollars. Notice the latter $XAW is ex-Canada which means that it doesn’t invest anything in Canada, which is great because like me, most Canadian investors are overweight in Canadian equities.
As an aside, for beginner or novice investors, particularly young investors or those just getting into investing, I recommend a Robo-Advisor for investments. I recommend WealthSimple (paid affiliate link)(for those in Canada. As they say, it’s “Investing on autopilot”. It’s ideal for beginners who want to get into investing and build a hands-off portfolio of low-cost globally diversified funds, or for those that just prefer to do other things than worry about their investments.
As more experienced and comfort with risk or otherwise is gained, an investor can select individual dividend paying Canadian stocks on the TSX. More on that approach in a future blog post.
Why Hybrid Investing?
As a hybrid (active) dividend stock and (passive) index fund investor, you can benefit from both active and passive investment strategies. Here are some advantages:
- Diversification: By investing in both individual stocks and index funds, you can spread your risk across a wide range of investments.
- Passive and active management: Index funds provide low-cost, diversified exposure to the market, while individual stock investments allow for active management and potential higher returns.
- Risk management: Index funds can help mitigate risk by tracking the performance of a specific market index, while individual stock picks can offer the potential for higher returns.
- Flexibility: Being a hybrid investor allows you to adjust your investment strategy based on market conditions and your risk tolerance.
- Potential for outperformance: By combining the benefits of both strategies, you may have the opportunity to outperform the market over the long term.
Overall, being a hybrid dividend stock and index fund investor can offer the advantages of diversification, risk management, flexibility, and the potential for higher returns. Mark Seed over at My Own Advisor outlines how he built his investment portfolio as a fellow self-proclaimed hybrid investor.
So bottom line: I’m a hybrid investor focused on dividends from individual stocks in Canada and total returns from index funds such as $VTI and $XAW internationally given the challenges with stock selection from a very large U.S. and global stock market.
In essence, I’m trying to capture the best of both worlds: dividend investing and total return investing. In Canada, I’m a dividend investor buying individual dividend paying stocks and outside Canada, I’m largely an index investor, seeking total return (albeit while also collecting dividends from funds such as $XAW and $VTI).
The Focus of my Hybrid Investing Approach is Dividends
Dividends from stocks can be advantageous for investors like me for several reasons:
- Passive Income: Dividends provide investors with a source of passive income. This income can be especially beneficial for retirees or those looking to supplement their regular income.
- Stability and Predictability: Companies that pay dividends regularly tend to be more stable and mature. This can provide investors like me with a predictable income stream, even during times of market volatility.
- Long-Term Growth: Reinvesting dividends can accelerate the growth of an investment portfolio through compounding. Over time, this can result in significant wealth accumulation. With few exceptions, I have religiously reinvested my dividends.
- Risk Management: Companies that pay dividends are often financially healthy and profitable. Hello Alphabet! Dividend payments can act as a signal of a company’s stability and commitment to returning value to shareholders.
- Inflation Hedge: Dividends can act as a hedge against inflation. Companies that consistently increase their dividends over time may help investors maintain their purchasing power in inflationary environments.
- Tax Advantages: In some jurisdictions, dividend income is taxed at a lower rate than other forms of investment income, such as interest income. This can result in tax advantages for investors receiving dividends.
Overall, dividends provide me with a steady income stream, long-term growth potential, risk management benefits, an inflation hedge, and tax advantages.
As I pointed above, investing in individual Canadian stocks as opposed to owning a TSX index fund that tracks the overall Canadian stock index, can have its advantages, especially when it comes to dividends and sector concentration. Here in greater detail are some reasons why buying individual Canadian stocks may be more beneficial in certain aspects:
- Dividends:
- When you invest in individual Canadian stocks, you have the flexibility to select companies that have a history of paying higher dividends. Some companies, particularly in sectors like utilities, telecommunications, and financial services, are known for their consistent dividend payments and growth. By picking these individual dividend-paying stocks, you can potentially generate a higher income stream compared to what you might receive from a TSX index fund, which holds a broad range of stocks with varying dividend yields.
- Sector Concentration:
- The Canadian economy is highly concentrated in sectors like financials, telecommunications, and energy, as I’ve noted previously. By investing in individual Canadian stocks, you have the advantage of focusing your investments on specific sectors that you believe will outperform or provide stable returns. This targeted approach allows you to capitalize on your knowledge of these sectors and select companies that you believe have strong growth prospects or are undervalued in comparison to the broader market.
- Easier Stock Selection:
- The concentrated nature of the Canadian economy can make selecting individual stocks easier for investors who are familiar with these specific sectors (Hint: You don’t need any sector specific knowledge). This targeted approach to stock selection can potentially lead to better performance compared to a more diversified index fund.
While there are benefits to owning individual Canadian stocks, it’s important to consider the associated risks and challenges as well. Investing in individual stocks brings with it company-specific risks: If a company tanks they may cut their dividend or discontinue it altogether.
Index funds and Exchange Traded Funds (ETFs), on the other hand, offer instant diversification and are passively managed, which can be beneficial for investors seeking broad market exposure with lower maintenance requirements, in addition to the fact that index funds are self-replenishing as the weak performers are dropped and new stronger performers are added. Read The Simple Path to Wealth (paid affiliate link) for a much deeper dive into index investing.
Dividend Investing vs. Total Return Investing
To determine which strategy is superior, one could look at a stock market like the TSX or The Standard and Poor’s 500, or simply the S&P 500. Comparing the performance of an index over the past five years to owning individual index stocks over the same time period involves several factors to consider.
Investing in an index provides exposure to a diversified portfolio of large and mid-cap companies, offering broad market exposure and potentially reducing individual stock risk. The performance of the index reflects the overall performance of the particular stock market as a whole.
On the other hand, owning individual index stocks allows investors to potentially benefit from the performance of specific companies that outperform the broader market. However, this approach also carries higher risk due to the lack of diversification compared to investing in the index.
To determine which strategy would have been more profitable over the past five years, it would be necessary to analyze the specific stocks chosen for individual ownership and compare their returns to the performance of the index overall during the same period. Additionally, factors such as transaction costs, time spent on research, and the ability to effectively manage a diversified portfolio should be considered when deciding between these two approaches.
I won’t do the math here as many others have done the math for us. And it’s compelling. Total return investing has been showing to produce superior outcomes as compared to dividend investing. The data doesn’t lie folks.
A recent article from Dale Roberts entitled, “The Dividend Don’t Matter” makes this clear. The article is nicely summarized by Dale as follows:
- Dividends don’t matter in the accumulation stage or in retirement; total return and risk level are what determine portfolio success, in my view.
- Many self-directed investors focus too much on dividends instead of making more money and creating a larger portfolio.
- Dividend metrics and strategies, such as dividend growth stocks and dividend-focused ETFs, have recently underperformed the market.
- More money creates more retirement income. Go for total return in the accumulation stage.
Others have recently made the same case:
As I explained on X/Twitter recently, personal finance is personal. What works for me, may not work for others.
I’m a hybrid investor: index funds + individual dividend paying stocks (mostly in Canada). Why? Because I recognize the value in both, particular as a Canadian investor.
Dividends provide a truly passive stream of income without me having to worry or think about selling stock in a bull or bear market to fund my retirement and all the complications (mental and otherwise) that go along with that.
A good real world point along this line is made below. Retirees need money to pay their bills to buy groceries, etc. To generate cash, a retiree will either have to constantly roll the proverbial dice selling growth, which they will inevitably have to do in both bull and bear markets at a discount.
Or, in the alternative, the same retiree can choose to accept a slightly lower return for the predictability of a relatively stable cash flow in the form of dividends.
Of course, they can do so all the while protecting their capital by not spending it down (at least for a period of time – usually 10 to 15 years into retirement to address challenges associated with sequence of returns risk and to not “Die with Zero”) (paid affiliate link).
Sequence of returns risk is the danger that the timing of withdrawals from a retirement account will have a negative impact on the overall rate of return available to an investor. This can have a significant impact on a retiree who depends on the income from a lifetime of investing and is no longer contributing new capital that could offset losses.
In the end, my philosophy in life can easily be summarized by the acronym KISS: Keep it Super Simple. For me, particularly with respect to Sequence of Returns Risk that rears its ugly head early in retirement, I prefer to draw dividends only for a period of time while letting my capital continue to compound unimpeded. Although I plan to continue to do some work and earn some money in early retirement, I do need predictable cash from dividends to you know, pay the bills.
In other words, withdrawals from an investment portfolio during a market downturn could mean there is not enough capital left when the bear market turns to a bull market to enable the retiree to live off their portfolio as the growth/compounding power of the investment porfolio has been diminished given the lower capital base left after withdrawals in a bear market.
There is by the way, where the safe 4 percent withdrawal rule of thumb comes from, in an effort to avoid a sequence of returns death spiral during retirement.
At the same time, I’m not ignorant to the fact that a total return approach is superior. I know what the data is in this regard. So in the end, both dividend investors and total return investors are wrong yet right.
So yes, I’m prepared to forego some growth to sleep well at night and keep my life and investing approach super simple that enables me to get out from behind a spreadsheet and enjoy things that make life worth living.
And right now, for me that is a recent transatlantic cruise followed by a solo cycling adventure through parts of the Dolomites of Austria, and into Slovenia and Italy.
