powered by GlobeinvestorGold.com

Rob Carrick

In this Issue

In the summertime ...

Rob Carrick

 

It's summertime and the living is easy if you own a dividend fund.

Dividend funds, whether they're in the form of an exchange-traded fund or mutual fund, are as low stress a way as you're ever going to find to get exposure to the broad stock market. You buy them and then repair to the hammock in your backyard. End of story.

No doubt you've heard that the stock markets are vulnerable to a decline after more than four straight years of outlandishly good returns. Bank on it - the markets will fall. When they do, dividend funds will lose ground, but they may just surprise you with their resilience. Let's take the years 2001 and 2002 as examples. The S&P/TSX composite index lost 12.6 per cent in 2001 and 12.4 per cent in 2002, which over the two years would have turned a $5,000 investment into $3,828. Dividend funds were a cool summer breeze by comparison.

The average fund in the Canadian and dividend and equity income category actually turned a 1.2-per-cent profit in 2001 and then lost 5.4 per cent in 2002. Over these two years, a $5,000 investment would have declined modestly to $4,787, which is $959 better than the index.

The typical trade-off for down-market protection is less upside, but dividend funds can be exception. The average mutual fund in the Canadian and dividend and equity income category made a compound average annual 10.5 per cent over the 10 years to May 31, while the S&P/TSX 60 total return index (a benchmark for blue-chip dividend stocks) made 10.6 per cent. The performance of dividend funds factors in the average 2.35 per cent management expense ratio for these funds. If you were to invest in the S&P/TSX 60 index through an exchange traded fund, your return would be reduced by the ETF's management expense ratio of 0.17 of a percentage point. So a more fair comparison would be 10.5 per cent for dividend funds and 10.4 per cent for the index. Hair-splitting on fees aside, it's clear that dividend funds deliver competitive returns in the long term.

There are two reasons for this rare mix of offence and defence in a single investing product. One is the fact that dividend stocks are typically blue chips with a long record of profitability and stability (the qualities needed before a company can pay a dividend). Second, there's the dividend itself. Dividends offer a stream of income that adds to your return in good years and acts as a cushion in bad years. If a stock declines 3-per-cent in price in a year and pays an annual dividend yielding 3.5 per cent, then a shareholder's total return (share price move plus the dividend yield) would be 0.5 per cent.

There are two ways to buy dividend funds, the most common as a mutual fund. Virtually all fund families have dividend funds today that focus on the Canadian and sometimes U.S. and global markets. Another option is a dividend-focused exchange-traded fund, of which there are two listed on the Toronto Stock Exchange. One is the iShares CDN Dividend Index Fund (XDV-TSX), which has a yield of about 2.8 per cent and counts Canadian Imperial Bank of Commerce, Manitoba Telecom Services, Bank of Montreal, Toronto-Dominion Bank and Teck-Cominco as its Top Five holdings. The other is the Claymore CDN Dividend & Income Achievers ETF (CDZ), which has a yield of about 4.3 per cent and holds a mix of both dividend stocks and income trusts. Note: top holdings include volatile names such as Fording Canadian Coal Trust and Chemtrade Logistics Income Fund as well as stalwarts like BMO and IGM Financial.

If you own a dividend fund, it's not necessarily summertime year round. Remember, dividend funds do go down sometimes. Still, if you want an easy-to-live-with investment that looks after itself, dividend funds rule.

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

Back to top