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Topic: How To Invest
June 5, 2023|by Scott Clayton
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Take into account various options when you consider dividend vs index investing: Not all index investments are equal, and dividends are a true sign of investment quality.
One big advantage of index funds when weighingdividend vs index investing is that they can help you avoid the risk of choosing a mutual fund with a management style that virtually guarantees below-average long-term performance.
Another advantage of index funds is that they can give investors with limited funds a low-cost way to get some stock-market exposure. They can also be a good starting point for a registered education savings plan (RESP), or a child’s in-trust account. Many investors also consider them when they invest funds in their tax-free savings accounts (TFSAs).
How Successful Investors Get RICH
Learn everything you need to know in 'The Canadian Guide on How to Invest in Stocks Successfully' for FREE from The Successful Investor.
How to Invest In Stocks Guide: Find 10 factors that make your investments safer and stronger.
Dividend vs index investing: Reasons why investors like index investing with ETFs
The MERs (Management Expense Ratios) are generally lower on ETFs than on conventional mutual funds. That’s because most ETFs take a much simpler approach to investing. Instead of actively managing clients’ investments, ETF providers invest so as to mirror the holdings and performance of a particular stock-market index.
ETFs practice this “passive” fund management, in contrast to the “active” management that conventional mutual funds provide at much higher costs. Traditional ETFs stick with this passive management—they follow the lead of the sponsor of the index (for example, Standard & Poors). Sponsors of stock indexes do from time to time change the stocks that make up the index, but generally only when the market weighting of stocks changes. They don’t attempt to pick and choose which stocks they think have the best prospects.
This traditional, passive style also keeps turnover very low, and that in turn keeps trading costs for your ETF investment down.
Industry specifics are important factors when you’re comparing dividend vs index investing
Should I buy dividend stocks? It’s a question many new investors ask. Our answer is always “yes.” We look for Canadian dividend stocks that have industry prominence, if not dominance. Our reasoning, besides brand recognition, is that major companies can influence legislation and industry trends to suit themselves. Minor firms can’t do that.
For Canadians asking “should I buy dividend stocks?”, it’s important to remember that Canadian dividend stocks are an important contributor to your long-term gains, and dividend-paying stocks tend to expose you to less risk than non-dividend-payers. That’s why the majority of your stocks should be dividend-payers at all times. As you get older and closer to retirement, you should raise the proportion of dividend-paying stocks in your portfolio, to cut risk and improve the stability of your investment results.
Dividend vs index investing: Should I buy dividend stocks? Yes, dividend-paying investments can be among your best holdings
We’ve always placed a high value on a record of dividends, mainly because it provides something of a pedigree for stocks we recommend. That’s another reason why we always answer “yes” to the question, “should I buy dividend stocks?” After all, you can’t fake a record of dividends. It takes a lot of success and high-quality management for a company to have the cash and the determination to declare and pay a dividend every year for five or 10 years. It’s not something you can create at the spur of the moment.
If you stick with top-quality, high dividend-paying stocks, the income you earn can supply a significant percentage of your total return—as much as a third of your gains. And at the same time, dividends are more dependable than capital gains as a source of investment income.
We think Canadian dividend stocks are some of the best investments you can own. That’s another way of answering the question, should I buy dividend stocks?
Dividend vs index investing: The best of both worlds
There are ETFs that pay dividends, which is important to note while looking at dividend vs index investing.
Overall, we recommend looking for dividend-paying ETFs that hold companies with records of long-term success and a long history of payouts. These companies are the most likely to keep paying and increasing their dividends.
3 tips for finding the best dividend-paying ETFs
So, you’ve answered “yes” to the question “should I buy dividend stocks?” Now here are three key tips to finding the best of those income providing stocks.
- Know the economic stability of countries when investing in international dividend ETFs. It’s also worth mentioning that foreign leaders may not be your ally when it comes to passing legislation that can affect your investments.
- Know how broad the dividend ETF is, so you can determine its volatility. The broader the ETF, the less volatility it may have. A sector-based ETF, like one that tracks resource stocks, may be more volatile.
- Know the current financial health of each company in the ETF. If a company is doing well, has done so consistently, and shows signs of growth, these factors are indicative of stocks that will keep paying a dividend.
Bonus Tip: An added benefitfor some dividend stock investors
Dividend reinvestment plans, or DRIPs, are plans some companies offer to allow shareholders to receive additional shares in lieu of cash dividends. DRIPs bypass brokers, so shareholders save on commissions.
DRIPs also eliminate the nuisance effect of receiving small cash dividend payments. Second, some DRIPs let you reinvest your dividends in additional shares at a 5% discount to current prices. Third, many DRIPs also allow optional commission-free share purchases on a monthly or quarterly basis.
Generally, investors must first own and register at least one share before they can participate in a DRIP. Registration will generally cost $40-$50 per company. The investor must then notify the company that they wish to participate in the company’s DRIP.
An extremely high dividend yield can be a sign of danger. Have you chased a high dividend before, and if so, what led you to take the risk?
If you had to choose between investing in an index fund or dividend stocks, what would factor into your decision?
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