Monday, August 29, 2011

Dividend investing vs Index investing

Today, I wanted to share some of my thoughts about one of the more popular amateur investor debates:

Dividend investing vs Index investing.

I'm a busy investor. Just tell me which one is better!

If only it were this easy.

There are many proponents on one side or the other. Here are a few of each, for your perusal:

Dividend Monk
Dividend Ninja
The Dividend Guy
Dividend Pig
Invest It Wisely

Oblivious Investor
Millionaire Teacher (Andrew Hallam)
Canadian Couch Potato

Most of these folks respect the 'other sides' investment choices, but generally prefer to go with one or the other.

I haven't decided my primary investment strategy yet (other then a handful or dividend stocks that I cut my teeth on), so I'm very interested figuring this out myself.

I'm going to compare the two in a general way (I am not an expert, and these lists are not exhaustive).

Why Indexes are great:
  • Similar to a mutual fund in that it holds many stocks, in this case, from a tracked index, (such as TSX, S&P, etc).
  • Attempts to follow the trends of it's market index - Which in the past have been generally 70% positive, 30% negative.
  • Will never 'bust' unless nearly the entire stock market 'disappears'
  • Generally has very low MER (Management Expense Ratios) so it is inexpensive to invest in.
  • You can invest in multiple indexes, and have a portfolio that virtually covers many countries and markets, offering unparalleled diversity.
  • You can profit from the shifting currents between indexes (during your 'rebalances').
  • You don't need to buy and sell often, just 're-balance' your portfolio perhaps a few times a year to bring it back into line. I like to refer to this as The Ratcheting Effect.

    Why Indexes are bad:
    • Since indexes track the market, they can also track it off a cliff into a crash (although you will be in a better position then most).
    • It's 'boring' (no thrill of the hunt for excellent stocks, just the same index funds, over and over)
    • You won't need to trade often, so that can mute any excitement about investing.
    • The upcoming markets may slow to the point where you are not 'gaining' very much in capital gains over time, but this is universal for most any stock.

      Why Dividends are great:
      • You can pick and choose exactly companies to invest in.
      • You can leverage insider knowledge about company performance to purchase your dividend stocks when they are at their best 'value' (lowest cost).
      • You can enjoy a constant, small stream of income as these companies pay out dividends to you at regular intervals.
      • Long-term dividend paying companies tend to be well-run, and more resistant to wildly fluctuating stock prices and values, helping to keep your investment stable-ish.
      • During a 'crash', you may be in a better position then non-dividend investors due to the continual income from dividends (but only if your companies manage to keep up the payments during the slump).
      • Some companies offer what is known as a 'DRIP' or Dividend Re-Investment Program' - This program will reinvest your dividends into more stock from the same company, often at no additional cost to you, and sometimes at a discount to the regular market price. (Some investors swear by DRIPs).
      • Dividends paid by qualifying Canadian companies in Canada are given a *very* preferable taxation rate.

      Why Dividends are bad:
      • Low Diversity - You will only invest in companies that pay enough dividends to interest you - This limits your selection of stocks, and will almost definitely keep you from picking up any high-capital growth stock.
      • Companies may drop dividends for any reason, or no reason at all. They are not beholden to pay them (Unless you are purchasing preferred shares, or shares with other, special conditions).
      • The few companies you invest in (compared with the hundreds in an index) leaves you open to losing all your money if the company folds.

      But which one is better?

      Dividend stocks simply pay out the dividend from their market value, so they generally have slower growth. But, you are being paid with 'today's' dollars, which means that they are worth more then 'future' money that is felt the effects of inflation and market growth (devaluation).

      Indexes tend to slowly gain over time, when you filter out the market noise. You can also profit quite handsomely when you re-balance due to one sector doing much better then another.

      You will have to make up your own mind about which investing strategy you will use, but I hope this simple primer will provide you with some insight when it comes to dividend and index investing.

      What are your thoughts when it comes to dividend and index investing?
      Do you use one style or another yourself?
      Let me know :).

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