The following question is from JS:
The following I found at dividendgrowth.ca. What are your thoughts on this opinion?
“I do not buy ETFs because, essentially, I reckon you are buying an index. In the tech crash of 2000, indexes went down…some, way down. My dividend growth stocks went up. I’d rather pick my own assets…safer dividend-paying stocks. I only have one retirement portfolio. I don’t know if ETFs provide income or if one just tries to make gains by trading, as the name suggests. You have to pay a commission to buy and sell ETFs. And they don’t always trade at the net asset value of their underlying holdings.
John Bogle, according to The Economist, is “the most vocal critic of ETFS”. He thinks they are undermining the buy-and-hold principle of sound investing by tempting the little guy into ill-timed ‘performance chasing’. Trading commissions notched up by all this activity could overwhelm the cost advantages of ETFs. Trading is too much bother. To make it profitable you have to guess correctly twice. Once when you sell, and once when you buy back in: you could lose on both counts.
I don’t want to start an all out war between the dividend-growth and indexing schools of thought. While I’m mostly indexed, I do own some dividend-growth stocks (yes, you can call it the triumph of hope over experience, but at least it is only a portion of our portfolio). However, there is one drawback in buying just a handful of stocks: you better hope that you don’t make a mistake and choose the wrong stock because if you lose a chunk of your capital, it is very hard to make up.
That said, I think Tom Connolly criticizes ETFs for the wrong reasons: ETFs do not trade at significant discount or premium to NAV and shouldn’t be avoided just because others trade them rapidly. Closed-End Funds (CEFs), which do trade at significant discount/premium to NAV, are frequently confused with Exchange-Traded Funds (ETFs). ETFs do not vary much from the underlying NAV because when they do arbitrageurs step in to redeem or create ETF units, a feature not available with CEFs.
I find it a bit rich that Tom Connolly quotes John Bogle to attack ETFs, because Mr. Bogle’s comments are directed at investors who trade too much. While investors in the U.S. have excellent index mutual funds available from Vanguard and other low-cost providers, ETFs are the only cost-effective option for many asset classes for Canadian investors. Just like quality stocks, if you buy-and-hold ETFs that track the broad indices, you are likely to be very happy with the results.
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15 responses so far ↓
1 Traciatim // Dec 9, 2007 at 9:35 pm
I was under the impression that you may want to avoid dividends in retirement as the gross up calculation makes it look like you made 145% of the money you really did and then this will be used for claw-backs from OAS and possibly effect other benefits as well.
2 Phil S // Dec 9, 2007 at 10:27 pm
To Traciatim… That was my point exactly! The way that the dividend tax credit is calculated is bad for retirees in terms of their Old Age Security.
My argument against ETFs (and pretty much every mutual fund of large cap Canadian equities) is that a market weighted fund will mostly consist of only a handful of stocks anyways. For example, the 2 or 3 largest REITs make up the majority of the market cap of a REIT index fund. I think the Big 5 Banks plus Manulife Financial make up the majority of any Dividend index fund. So why bother paying any MERs at all (even if it is less than 1%) if you can just buy the exact same stocks that make up most of the index. In the case of RioCan, H&R and the Big 5 Banks, they have a huge amount of liquidity and often the spread between the Bid & Ask prices are pennies. Millions of shares trade hands every day in those shares. So why bother paying any MER at all when you can build the exact same portfolio today with a minimal amount of one-time brokerage commissions?
3 FourPillars // Dec 10, 2007 at 12:16 am
I think that the Bogle example is taken a bit out of context - Bogle is not saying buy individual stocks because ETFs are too easy to trade, he’s saying buy index funds (which have trading limits) instead of ETFs. Index funds and ETFs basically hold the same securities but most mutual fund companies limit trading in index funds which according to Bogle will help your returns.
Traciatim - you would need a pretty significant portfolio to be affected by the OAS clawback but it is a valid concern.
Phil - I think it depends on the index you are talking about. REITs and Canadian dividend stocks are probably best example of where buying the individual stocks makes sense. However if you are trying emulate the top 60 Cdn stocks then you will have to buy quite a few securities. Obviously for US or Europe or anywhere else, you won’t be able to get the diversification without ETFs.
Mike
4 MillionDollarJourney // Dec 10, 2007 at 8:17 am
If you’re still fairly young, who’s to say that OAS will still exist when you turn 65? I’m a believer that CPP may be safe, but with an aging demographic, i’m not so confident about OAS as it’s paid out of the tax base.
5 CanadianInvestor // Dec 10, 2007 at 9:33 am
While historically the first ETFs were index funds, that’s no longer true and many are actively managed. An ETF is a corporate and legal structure, an alternative structure to mutual funds. It makes no more sense to criticize all ETFs than it is mutual funds. It is the fees and the investment strategy that count. What unwise investors decide to do with them is their problem, not that of the ETF merely because it can be traded easily. Mr. Bogle, when he takes shots at ETFs, says that investors have to be protected from themselves. Instead, I think they should figure that out themselves and sign themselves up for the investing version of Alcoholics Anonymous.
6 TonyR // Dec 10, 2007 at 11:00 am
I think people should remember that the last time index investing was being talked up was 1999 when markets were soaring (like now) AND just before the markets dropped significantly. Like most investing methodologies, the most popular one is usually 5 years too late. An out of style methodology is more likely to make you more money. Remember in 1999, Warren Buffet was considered out of date.
7 Qcash // Dec 10, 2007 at 11:19 am
I agree with MDJ about planning a retirement strategy around the OAS is strange.
I hope to have such a huge portfolio and income in retirement that I could care less about the OAS.
Q
8 moneygardener // Dec 10, 2007 at 11:21 am
I can see both sides of the argument. It just depends what the market does. I agree that in a dramatic run up followed by a dramatic correction I would not want to be indexed. In this situation I would not worry as much about my portfolio of dividend growing stocks.
You could argue too that with the proliferation of derivitives hedge funds etc., there is more likely to be more wild swings in the market than there has been historically so the indexer could be in for a bumpier ride than the large cap dividend growth investor.
9 Canadian Capitalist // Dec 10, 2007 at 11:35 am
FT: I share your opinion about OAS. Who knows what will happen to the program in 30 years? Also, even the CPP isn’t a sure thing. Yes, they say the CPP is in good shape but that doesn’t mean they could tinker with the benefits. A few months ago, the press reported economists recommending increasing the CPP age to 67 and cutting benefits for early retirees. Thirty years is a long time; anything could happen…
10 Canadian Capitalist // Dec 10, 2007 at 12:36 pm
MG: And who knows what the market will do in the future? If as you say dividend-paying stocks (as a group) have lower volatility than broad-based stock indices, then according to theory at least you can expect them to have lower returns.
11 moneygardener // Dec 10, 2007 at 2:59 pm
Yes, you would expect that to be true - although, when you include dividends, high dividend paying stocks have outperformed the broad indices when you include dividends over long periods of time.
12 Canadian Capitalist // Dec 10, 2007 at 6:18 pm
MG: Do you have any studies that show that dividend payers as a group outperform a broad index with less volatility, which seems to me is saying you can get more reward without taking on more risk?
13 Plan Your Escape // Dec 10, 2007 at 7:38 pm
I’m also in the Don’t-Count-On-OAS-Or-CPP camp on this one. I’ve got many years until that becomes an issue and I’m going to make sure I’ve got my own retirement covered. In the meantime I’m making full use of the tax credits available today. I don’t want to end up relying on OAS or CPP.
14 Cristian // Jan 25, 2008 at 10:44 pm
Just to let you know that OAS clawback starts to kick in at >65K year income. I would not mind if I had this kind of income in retirement. Most people who’s income is <65K / year, will not be affected by dividends.
–cristian
15 Traciatim // Jan 26, 2008 at 1:37 pm
Are the calculations done on the actual amount of the dividends, or the grossed up amount though like they would be for your child tax benefit?
Here’s a situation, say a couple are both 50 and they just saw their kids through school so they have no savings. They think ‘Holy crap, what should we do?’, they have such a pile of choice it’s insane, but it comes down to thee basic things:
1) Do nothing
2) Save/Invest in an RRSP
3) Save/Invest Outside an RRSP
Lets go through 1 and 3 just for ease, since it gets really darn complicated with all the stuff they could do.
In one, they do nothing. They retire at 65 having enjoyed the last 15 years to a combined monthly income with OAS and GIS of: 921.00, for a total of 1842 a month giving them 22104 a year.
In three, they scrimp and save as much as possible and in 15 years each have 250000, they decided a complete dividend strategy where they make 4% yields reliably is for them. So they each make 10000 a year. This is grossed up on line 236 of their T1 forms so it looks like they each make 14500 in the eyes of the government. Since they make 29000 in family income they OAS/GIS each would end up being 502 per month each, 1004 combined or 12048 yearly. So this couple sacrificed for 15 years to come out with 20000+12048 or 32048 per year. Now, since they made dividend income, their OAS payments will be taxable as actual income. So in Ontario they marginal rate would be something like 20% so they would owe back something like 2400 bucks or so leaving them with around 29.6K per year of usable income.
So, it comes down to:
1) 15 years of using your full income to enjoy life because your kids are gone and then retiring on OAS/GIS
2) 15 years of sacrifice for an increase of spendable income by 7.5K a year.
I dunno, is it really worth it?
I don’t want anyone to misunderstand, I’m only 28 and I’m packing away for my retirement, and hope to not have to rely on any social programs when I retire, but there are many (probably the majority of) people in the situation above. What’s the incentive for them to continue saving when they can just rely on the rest of us to put them through their retirement years.
If you own a house, your watching your children make families of their own, and you keep your expenses low by keeping your spending under control two people can live quite easily on 22K a year.
It’s not only OAS, keep in mind the GIS and Allowance (I’m not sure on the allowance and all these rules, so don’t quote me) are clawed back from dollar one.
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