Passive Income is great – but there is more to investing…
Passive Income, and dividend investing are amazing. Who doesn’t love getting paid for doing nothing? I am a huge proponent of building up a portfolio of stocks and funds, that pay out distributions – however there is more to investing than just maximising your monthly income. In fact, a HUGE mistake I see a lot of people making with their investment plan is their sole focus is maximising their monthly income, with little regard, or even idea how their portfolio is performing.
While this may be a viable strategy for someone who has already retired, or hit financial independence, this article is for us younger investors with time on our side, and for new investors just getting started. I constantly see people online asking for investing ideas, and one common theme is that they always seem to be looking for:
- The Highest yielding stocks
- How to get rich quick(gamblers – not investors)
- Stocks that pay monthly dividends
I also noticed (and I am guilty of this too) that the majority of financial bloggers, post a monthly income update, however very few post their total returns. In fact, after speaking with many – some don’t even know what their actual returns are. Why is this important? To answer that, let’s get a better understanding of how people typically build wealth and retire.
The phases of building wealth
Phase 1: Accumulation & Growth. Patience, high risk – high reward.
When you are young, you have time on your side. You can handle market fluctuations, and you should be more comfortable taking some risks with your investments. By risks, I don’t mean throwing all your money into penny stocks. When I say risk, I mean you should have a high % of your portfolio in equities, and be be comfortable owning more growth oriented stocks. All investments should be reinvested/compounded and you should continue to put as much money away as you can (while living the life you enjoy). At this stage in your life, you are working, and don’t need your investments to provide you with any additional income – yet we all seem to be focused so much on our dividend income at this stage. Instead – focus on growing your portfolio as large as you can. When the time comes, it’s easy to switch your investments to income producing ones. To be clear, I am not advocating you don’t own any dividend paying stocks at this stage -In fact, a lot of dividend paying companies are great long term wealth building companies. Just be weary of what you are looking for in a stock. A company that pays a 3% dividend and grows it’s dividend each year by 10%, and also has stock appreciation each year, is much better than a 6% dividend with 0 dividend growth and 0 capital appreciation. Typically higher yielding stocks also have a higher risk associated with the dividend being cut in the future as well (which typically is followed by a reduction in the share price). Always take into account a stocks payout ratio, revenue growth, debt load and history of dividends(among other things).
Phase 2: Risk Reduction – Determining your retirement needs
As you get closer to retirement/living off your investments, you can begin shifting your higher risk growth stocks, into some more income producing assets. This can be both fixed income assets, or dividend paying stocks/funds. Keep in mind inflation will eat into those returns, so always look for companies with a history of increasing their payments and a strong outlook. In this phase you should know how much income you need to spurn off from your investments to adequately cover your expenses/retirement. Most people will include drawing down from their capital, while the VERY ambitious among us will try to live 100% off the income without ever drawing the capital down(thus leaving a large fortune to the estate).
Phase 3: Reducing Taxes, Retirement, Enjoying Life & Estate Planning
You are ready to retire/live off your investment income. By now you should have met with a tax specialist to ensure you are minimising your tax burden, have a will completed to ensure your family is taken care of, and most importantly enjoying yourself. You worked hard – now enjoy the fruits of that beautiful compounding snowball. Spend your money on things you genuinely love, and spend as much time with friends and family as possible!
This is an over simplified look at building wealth, and there are other strategies that work- but my main point is that I think it’s really important for younger people not to get caught up in the monthly income competition (if it ends up hurting your total returns).
Historical data is hard to find, but while searching for some of the top high yield stocks in 2015, here is a list of some that came up in an article on Canadianbusiness.com listing some Top high yielding stocks:
|ARC Resources Ltd.||ARX||4.8|
|Canadian Imperial Bank of Commerce||CM||4.4|
|Cenovus Energy Inc.||CVE||4.6|
|Crescent Point Energy Corp.||CPG||8.8|
|Husky Energy Inc.||HSE||4.5|
|Inter Pipeline Ltd.||IPL||4.7|
|Potash Corp. of Saskatchewan Inc.||POT||4.8|
|Rogers Communications Inc.||RCI.B||4.5|
Let’s see how they performed over the last 4 years:
|ARC Resources Ltd.||ARX||4.8||-73.39|
|Canadian Imperial Bank of Commerce||CM||4.4||35.82|
|Cenovus Energy Inc.||CVE||4.6||-51.37|
|Crescent Point Energy Corp.||CPG||8.8||-77.6|
|Husky Energy Inc.||HSE||4.5||-64.91|
|Inter Pipeline Ltd.||IPL||4.7||-14.74|
|Potash Corp. of Saskatchewan Inc.||POT||4.8||-28.92|
|Rogers Communications Inc.||RCI.B||4.5||44.44|
Had you invested equally in these 10 high yielding stocks in 2015, no doubt your monthly income would have been pretty sweet that year. The problem? After a few years, aside from 3 of the stock picks, you would have lost money on the other 7. And your total portfolio would be DOWN almost 20%.
Again, just to reiterate – I am not anti dividend paying stocks, or even high yielding stocks for that matter – I just want to emphasise there is a lot more to investing than just calculating your monthly income. Perhaps we (as the financial community) need to do a better job of reiterating this as well, because looking on Reddit, Facebook and Twitter, the majority of new investors seem to only care about boosting their monthly income by any means necessary – and in a lot of cases, the “means” is a reduction in total returns.
So why do total returns matter so much?
At the end of the day, we all want to live off an income stream from our investments. When that time comes, whatever you have in your portfolio can be moved to different stocks/bonds, funds, etc. If over the course of your investing career, you missed out on say 1-3% annual growth each year because you focused on monthly income instead of total returns, this could add up to hundreds of thousands of dollars over 20-30 years. Imagine how much extra monthly income you could generate in retirement with that when you actually NEED the income!
Real World Example:
I was recently chatting with Matthew from AllAboutTheDividends about his portfolio and his monthly dividend income (which is VERY impressive by the way) and if you don’t already follow him – you should – he posts a lot of great content on Canadian stocks. Check him out on Twitter
I noticed he has been consistently earning more dividend income than me (even though my portfolio is almost twice the size). I always knew my personal monthly yield was low (compared to most other bloggers), but this was really eye opening for me. I decided to ask him how his returns have been since he started direct investing…
In his most recent monthly updated I commented the following:
*First off, I want to thank Matthew for allowing me to share some of our conversation back and forth*
Matthew reached out via private message, and since I knew we both use the same investing platform, I showed him how he can track his overall returns within the platform. After some back and forth, he shared a screenshot of his total returns:
As you can see, Matt’s RRSP has done great since he started – beating his Benchmark by over 2%. Looking at his portfolio, you can see his RRSP consists mostly of big bluechip companies, such as: RBC, Bell, Telus, Bank of Montreal, Power Corp, Fortis, Bank of America, Johnson & Johnson and others. A well diversified, and really nice looking group of companies. You can view his full portfolio HERE
Looking at his TFSA return, is another story. Down almost 20% since inception. I asked him how this could be, and his answer is one that honestly doesn’t surprise me, because I see and hear it all the time:
I’m sharing this to hopefully help out some new investors reading this.
The only surefire way to ensure long term wealth from investing, is to continue to buy assets that appreciate, reinvest the dividends, and hold them for the long term. It’s boring, it’s simple, but it works.
Luckily Matt learned his lesson at a young age (I did too, my first ever stock purchase was based on a “hot tip”, and is now worth 0.00- as the company went bankrupt. Luckily I only invested a few hundred dollars). If you look at Matt’s TFSA now, it is full of some great names (Plaza, Canadian Utilities, Bank of Nova Scotia, Andrew Peller & CN Rail to name a few). Matt is well known in the online finance community, has an awesome, well diversified portfolio valued well over $100k and even he didn’t know what his total return was. Think about that for a second. We all get so caught up worrying about our monthly income, we sometimes forget about the big picture – total returns.
For transparency sake, here is my 3 year return since I started Direct Investing with RBC in my TFSA:
One thing I’ve noticed- which I love – is that the online finance community – although competitive – is also extremely helpful and wishing everyone else nothing but success! So in that spirit, I plan on including my portfolio returns each month, and I’d like to encourage everyone else to start doing the same.
Anyways, Cheers and good luck!