In the search for tax-efficient yield, individual dividend-paying stocks and exchange-traded funds holding baskets of these make more sense than ever in this seemingly perpetual low-interest world.
Investors can pick GICs or interest-only instruments that barely yield one or two per cent, and they\’re going to be taxed at the very top marginal rate if they are held outside registered plans. Or they can get more than twice that payout by holding dividends, using the added bonus of favourable tax treatment for Canadian issues.
Many individual stocks in addition to ETFs yield more than four percent per annum. For example, the iShares S&P/TSX Composite High Dividend ETF (XEI/TSX) currently pays 4.64 percent and the BMO Canadian Dividend ETF (ZDV/TSX) pays 4.3 percent.
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There are at least 20 Canadian dividend ETFs should you include preferred-share and income ETFs. Of course, many are heavily concentrated in financial stocks such as the big banks, which Canadian investors probably already own individually.
If you do not, the BMO and iShares dividend ETFs may do the job, as will the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY/TSX). Keep in mind the latter holds seven financial stocks in its top 10 holdings, by having an MER of 0.3 percent.
If you\’re looking for a dividend ETF to round out your portfolio with dividend payers in addition to the big banks, B.C.-based certified financial planner Fred Kirby is staying with his long-time recommendation of iShares S&P/TSX Canadian Dividend Aristocrats ETF (CDZ/TSX).
One from the fund’s rules is the fact that every holding should have increased ordinary cash dividends for at least five consecutive years. The MER is 0.66 per cent, higher than many, but that buys you contact with dividend payers you will possibly not otherwise have thought about: the top 10 includes stocks for example Bird Construction Inc., Mullen Group Ltd and Ensign Energy Services Inc.
The iShares\’ XEI is a tad less balanced than CDZ, Kirby said, but sports a great yield. To prevent sector concentration risk, a maximum of 30 percent of the fund can be allocated to anyone sector, and contains thus maxed out its contact with both financials and stocks.
The only bank in the top 10 holdings is CIBC; its top two holdings are telecom stocks BCE Inc. and Rogers Communications Inc., and the rest include Potash Corp. of Saskatchewan Inc., some REITs and stocks.
Surprisingly, some ETF experts are under enamoured with dividend ETFs like a broad category.
There are at least 20 Canadian dividend ETFs if you include preferred-share and income ETFs
Tyler Mordy, co-chief investment officer of Hahn Investment Stewards & Co. Inc., is generally wary of any ETF that departs from a market-cap-weight approach.
\”We generally favour low-cost, highly liquid, broadly diversified \’pure beta\’ however the firm uses dividend or other alternative-weight methodologies occasionally, but only if the underlying biases align with its active strategy outlook,” he said.
At one point, Hahn’s portfolios included Vanguard\’s Dividend Appreciation ETF (VIG/NYSE) if this needed exposure to high-quality U.S. multinational equities and also the ETF\’s weighting methodology caused it to carry large overweight positions in multinational consumer-staples and health-care names.
Portfolio manager Justin Bender at PWL Capital Inc. views dividend ETFs like a tax-inefficient \”value\” vehicle. (For details read his article Dividend ETFs: Value ETFs in Disguise). He compared two dividend ETFs from iShares (the Canadian Select Dividend Index ETF (XDV/TSX) and CDZ), and two iShares value ETFs (Canadian Value Index ETF (XCV/TSX) and?Canadian Fundamental Index Fund (CRQ/TSX)).
His conclusion? \”For everyone die-hard dividend junkies available, I\’m certainly not disagreeing together with your investment strategy (typically.) Dividend investing is just another type of value investing, and should therefore be expected to have higher returns.\”
But, he cautioned, investors should take the time to better understand the risks being assumed once they invest in undiversified dividend ETFs.
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Mark Yamada, president of PUR Investing Inc., is more upbeat on the general category of dividend ETFs, saying active rules-based strategies that consider items like dividend growth rates appear to make more sense than simple index-based (cap-weighted highest yields).
“We are more comfortable with rules that reflect what we would seek in individual companies rather than just the highest yields,” he explained. “Companies rich in dividend yields that are not growing earnings that support dividend increases are riskier than those that can.\”
All this said,?dividend ETFs are a relatively mainstream and low-risk suggestion for investors looking for a simple recommendation to hold in their TFSAs. Older investors likely have lots of individual banks and stocks within their taxable portfolios which they\’d rather not trigger capital gains, so for them, something like CDZ may make sense inside a TFSA.
Younger folks with less exposure to individual stocks will discover something such as XEI or VDY can perform the job, certainly in a TFSA (I personally own VDY in my TFSA). These dividend ETFs could also be held in RRSPs, however the latter is the optimum place for U.S. dividend ETFs and Canadian fixed income.
Jonathan Chevreau runs the Financial Independence Hub and could be reached at email@example.com