Experts say dividend-paying stocks are not for everyone

·5 min read

Bob Lai, a 39-year-old product manager and blogger in Vancouver, has an investment portfolio comprised of 51 dividend stocks and one ETF.

Lai started investing in his early 20s when ETFs weren’t widely available or popular. He started investing in mutual funds before moving on to individual stocks, such as Intact Financial (formerly known as ING) and Manulife, which were paying dividends and continued to do so after the financial crisis hit.

“[My partner and I] just thought that having that stable dividend income would be good. Living off those dividends would give us more flexibility rather than having to sell our principle and live off that. So that’s the attraction.”

Dividends typically pay on a quarterly basis and work like this: if you own 100 shares in Royal Bank of Canada, for example, and you receive $1.20 a share, every February, May, August and November, you’d receive a $120 deposit in your trading account, Lai said.

While some investors rely on a dividend stock investment strategy, the approach isn’t for everyone, experts say.

Dividend payers are typically established companies that have excess cash flow so they start returning that cash flow to their shareholders, explained Robb Engen, a fee-only financial planner at Boomer and Echo in Lethbridge, Alta.

These are often what are called blue chip companies, like RBC, Enbridge Inc., Telus Corp.and BCE Inc.

While there is nothing inherently wrong with investing in big blue chip companies, for most people, and especially young people, it shouldn’t be your whole strategy, Engen said.

Instead, younger Canadians should be focused on growth, and not the income they receive from their portfolio.

“You want to expand your investable universe into other stocks that don’t just pay dividends.”

Engen said that many people also don’t realize that a dividend payment is coming from a company’s earnings and cash flow. So, if you’re receiving $1.20 in dividends per share, the value of that company just decreased by that amount because they paid out the cash.

“Dividend shareholders could do anything with that cash. They could spend it. They could invest it in a different company. So the value of the company just went down,” he said.

“I think a lot of dividend investors think they see this dividend and they think they’re getting that return plus the capital appreciation, but the capital appreciation is being diluted every time the company pays a dividend.”

For example, when it comes to growth, Engen said that FP Canada’s projection assumption guidelines show that Canadian stocks,as a whole,have an expected return of 6.3 per cent before fees, U.S. and international stocks have an expected return of 6.6 per centbefore fees, and emerging market stocks have an expected return of 7.7 per centbefore fees.

So, if you invest in a company like ShopifyInc. that doesn’t pay dividends, your return would be linked to the value of the company growing. Your investment in the company is worth more because the share price went up, Engen said.

With a dividend paying stock like Enbridge, for example, the company is not quite so growth-oriented.

“They earn money from their pipelines, pay their expenses, and send the remaining profits back to their shareholders in the form of dividends. So, if you’re getting a six per cent dividend, you should not expect the share price to increase,” he said.

The company paying dividends is not investing as much in their growth via acquisitions or other avenues, he added. They have two different styles of company management.

“There is no free lunch. You don’t get the six per cent dividend that Enbridge is promising plus six per cent growth that you might get from a non-dividend payer."

Where a focus on dividend paying stocks might be beneficial is if you feel comfort from receiving a quarterly dividend, and that makes you hold onto the investment.

“If there’s a behavioural reason that keeps you grounded and keeps you from panicking and selling when the market goes down, then I think it can be a sensible strategy. It’s just not going to be the most efficient way to build wealth over time where you want to invest in the total market rather than concentrate on the dividend payers,” he said.

Instead, Engen recommends his clients keep their costs low and diversify broadly rather than focusing solely on one specific type of stock.

For the average Canadian, Lai, like Engen, is in favour of index investing with Vanguard or iShares ETFs, for example, and think it’s a good approach because you can just leave your investments and not have to think about them.

“But, if your personal preference is that you want that level of comfort in terms of having some sort of stable and predictable income, I think dividend investing is great because you see the numbers and the income coming in regularly,” Lai said.

In Lai’s case, by 2025 he expects to receive approximately $50,000 to $60,000 in dividends each year off the $1.5 million he has invested. Since he and his partner and two children have been living off $50,000 to $55,000 over the last seven to eight years, he said they’d be able to live off those dividend payments.

That said,Lai enjoyshis day job and has no clear plans to quit. If he were to one day stop working full-time, he would likely supplement his income with part-time work.

“I’m not in a rush to send in a resignation letter and chill on the beach every day. That’s not the plan.”

This report by The Canadian Press was first published May 31, 2022.

Companies in this story: (TSX:TKTK)

Leah Golob, The Canadian Press

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