- Focus on income rather than capital appreciation
- Dividend Aristocrat ETFs have consistently out-performed the market with less risk
- ETFs provide suitable alternatives to building your own individual stock portfolio
- Recommendations for UK, US and Canadian investors
One of the best ways to grow wealth over the long term is to focus on reliable, stable dividend and income producing assets and to hold them forever.
The challenge for individual investors is that trying to select stock portfolios yourself with smaller accounts (less than £250k) involves significant ‘frictional’ trading costs that often outweigh the benefits. In other words, you could just as easily own a tracker fund and obtain superior performance by allowing that fund to automatically allocate your money to shares.
There is a wealth of choice – today we aim to highlight why dividend aristocrat ETFs may have a place in your portfolio. This class of funds screens for reliable businesses that have a history of paying – and raising – their dividends. Furthermore the work of finding those shares and allocating money to them is done for you automatically.
They also tend to be diversified across sector and geography much better than a portfolio of self-selected shares.
What are Dividend Aristocrats?
One of the books on the Frugal Investors reading list is “Stocks for the Long Run” by Jeremy Siegel. Suffice to say that entire books (like this one!) have been written on the subject of why dividend-paying companies tend to outperform non-dividend paying companies.
Let’s define a dividend aristocrat. Dividend aristocrats are businesses that have consistently paid a dividend to shareholders, every year, for 25-years or longer. Think Coca-Cola, Proctor & Gamble, Exxon Mobil and 3M. We use their products every day! There are approximately 3,671 stocks that are listed on the domestic US stock market and about 142 of them (or 3.9%) have achieved that threshold. In fact, for American investors, that’s quite a few companies to choose from!
Doing the same analysis for the UK market tells us only 0.65% of listed stocks in London are dividend aristocrats, and a similar sort of figure for Canada too. So you are picking the crème de la crème!
Actually buying these shares individually and running your own global dividend portfolio is not for the faint of heart. I estimate that you’d require about £250,000 in assets to make this work and achieve superior performance without over-spending on fees. In addition it will take you at least a few hours a month to manage the portfolio.
Benefits of Dividend Shares
Dividend and income producing shares tend to out-perform over longer time periods with reduced risk. Here’s a great example from Jeremy Siegel’s book Future for Investors:
Over the very long term, from 1957 up to 2018 high dividend yielding stocks have outperformed their lower yielding peers by between 2.9-3.1% per year!
If that doesn’t sound like much, you ought to look at the differential: after 61 years that is the difference between having $1.29 million and having $218,405. That’s nearly a six-fold return for high-yielding stocks compared to low-yielding stocks.
The reason for the out-performance is manifold. By converting yourself from a ‘growth focused’ to an ‘income and dividend focused’ investor you will likely obtain much better returns over the long run.
- Dividends ensure that businesses are aligned to the needs of shareholders. They release capital from the business in the form of regular payments
- You can choose to invest income in whatever you want and if you buy more shares, you benefit from significant compound growth as those shares in turn earn you more income
- Dividends and income help prevent reckless take-overs and M&A activity, because Board members know that they have to portion off 30-50% (or more) of their profit in order to fund the dividend. Growth companies often don’t pay dividends and can therefore afford to take on more risk with their capital
- Once a business has a record of 10+ years paying dividends, Board members are very reticent to break the trend, because it is disastrous for the share price and oftentimes they have big shareholdings themselves
- Dividends signal that a business has stable and recurring profits, and by association, a stable business model and rate of return with a competitive moat – in order to fund the dividend!
- Of your total returns from stocks normally two-thirds (66.7%) of that return is due to dividends and income
- Dividend paying companies and portfolios have lower risk (as measured by stock betas of 0.95)
- Stocks and shares portfolios with a strong income focus produce higher income returns that prepare you for retirement, when you will look to draw an income from your investments
Rather than simply defending this position using data, numbers and fact; we’ve also got practical reasons why the underlying businesses perform better when they pay a stable dividend.
How to Invest in Dividend Aristocrats
For the majority of investors there’s excellent performance to be had through investing in stable, passive ETFs. Then you can sit back in your lawn chair and enjoy time with your kids (or friends!)
Let’s have a look at practical ETFs that you can invest in and how they perform against their respective benchmarks:
The S&P Global dividend ETF has out-performed the FTSE All-Share by 2.33% per year. Meanwhile the iShares Canadian Dividend ETF out-performed the TSX by 1.44% per year for a decade. Of course, the S&P SPDR ETF under-performed the return of the S&P 500 by 0.4%, but that’s a small figure and the S&P 500 has been effectively one of the best performing indexes of the last decade driven by technology and IT growth companies.
In fact all of these investments can be purchased through low cost, passive ETFs.
ETF Investments – A Deep Dive
In the UK we have selected the S&P Global Dividend Aristocrats ETF that invests across the US, UK, Europe and developed Asia. This ETF has beaten the FTSE All Share over 5- and 10-year time periods. It is diversified by sector and geography. In theory one could invest in this as a single ETF, given that it is spread geographically across UK, US, Canada, Europe and other developed markets. To find out more about this fund visit the independent fund rating website Morningstar here.
We have excluded the SPDR UK Dividend Aristocrats ETF on the grounds that it has significantly under-performed its category and benchmark since 2014. If you want to see why (and spot what to avoid), check out the fund here and look at the red line.
In the US we have selected the S&P SPDR Dividend ETF, which has had an absolutely stellar performance returning 12.93% per year since 2009. Given how immensely difficult it is to beat the S&P 500 Index, particularly over the past ten years, this is an impressive performance and a homage to stable dividend investing. The fund has great sector diversification however it is only invested in US-based companies. For that reason it would be best placed as a component of your portfolio rather than a single holding. Please note: for UK investors there’s risks to buying significant holdings denominated in US dollars.
In Canada we have selected the iShares S&P/TSX Canadian Dividend Aristocrats ETF, and the ETF has out-performed on all time frames apart from 1-year. That makes sense: the TSX has not been particularly strong over the past ten years and it has a high concentration in banks and oil companies. There is a lot to like about this iShares fund. It is only 19.77% concentrated in financials against 35.6% for the category. The ETF sports a 4% dividend yield with good diversification considering its assets are focused in Canada. Fees are a bit dear at 0.66% MER, though, so tread carefully. This ETF sits best as part of a larger portfolio.
The iShares S&P/TSX 60 ETF (XIU) is a tempting alternative, however it has under-performed the TSX index and also has quite a high weighting to banks – with Royal Bank of Canada 7.88% and TD Bank 7.11% respectively.
See how easy it is to compare ETFs? If they under-perform their benchmarks, treat with caution!
The evidence is overwhelming that, over the long run, stocks and shares that produce consistent dividends out-perform their growth peers by between 2.9% and 3.1% per year. Provided that you understand the reasons above – it is worth considering having a portion of your money invested in businesses that have been paying stable dividends for 25 years, or those that have 10+ years of dividend returns with growing payouts.
Remember if you’re new to investing, or you currently invest in active mutual funds, then this is a two-fold improvement on your current situation. Passive dividend ETFs have low running costs AND produce better total returns than their underlying benchmarks, with less risk!
Once you’ve gained experience investing, Frugal Investors may want to consider kicking it up a notch and fully investing their capital in dividend aristocrats and stable dividend growth companies – exclusively. In the next part of the series we’ll explore how U.K. and Canadian investors can shape portfolios around income and we’ll help you to select the best passive ETFs.