Dividend Stocks or Dividend ETFs: which one is better?
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My name is Alex and I love creating streams of passive income. My goal is to help you do the same.
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Announcement
I’ve recently signed up for my company’s Employee Share Purchase Plan. Every 2 weeks (when I get paid) a portion of my paycheck gets deposited into an account and buys shares of my company’s stock at a discount price. The best part? My employer matches my contribution up to 30%. Free money.
All of this is being done in the background with absolutely zero work on my end. I just need to show up to work as I normally would and my account gets funded, shares get bought and all of the dividends get reinvested automatically.
If you work for a publicly-traded company, I would suggest you look into these programs. From experience (and I’m not sure why), companies don’t always advertise these “perks”. It took me 6 months to figure out my company even offered such a thing. Just another way to buy income at a discount. Keep building your empires.
Pros of Dividend ETFs 👍
Saves you the headache of owning individual stocks
Let’s face it, owning individual stocks can be a headache. Especially if you’re managing your portfolio the way you should be as a “stock picker”. Constantly reading earnings reports, revaluing the company, making sure there are no material changes that could affect your position and doing ratio analysis.
What a headache! A dividend ETF helps eliminate that stress because no single company is going to have that much of an effect on the entire fund. So you essentially don’t have to worry about doing any of that. Just sit back and relax while your money does the work for you.
Market dips aren’t so bad
Theoretically, a market dip shouldn’t have that much of an effect on the value of your investment because your money is tied up in and spread across so many different companies.
For example, if you owned Walmart and the stock price dropped 30% tomorrow, then the value of your investment would fall by 30%. But if you owned Walmart within a Dividend ETF where the fund allocation to the stock was only 2%, then that drop would have a much lesser impact on the value of your total investment. The same is true if the stock rose in price as well.
Additionally, investors can feel more comfortable adding shares to their ETF positions on a dip because they don’t need to worry about the performance of 1 single stock in the fund. It saves you from having to think twice about if the stock will continue to fall. If the stock does continue to fall, then the other companies in the fund can pick up the slack, leveling out the total loss (or gain).
The simplest way to diversify
For a small fee (if you’re buying the right funds) your money can be spread across high-quality companies in one single fund. I like to buy Vanguard funds because they are known to keep their Management Expense Ratios (MER) extremely low in comparison to their counterparts.
Cons of Dividend ETFs 👎
Lower yields
Because ETFs track a broader market, the dividend yield of the fund will be naturally lower than if you were to hold an individual stock. For example, the dividend yield of Vanguard’s High Dividend Yield ETF (VYM) sits around 2.75%. That number will fluctuate depending on the yields of the companies inside the fund. Whereas an individual stock, let’s take SmartCentres (SRU.UN) for example, has a dividend yield of 5.61%, earning you significantly more income than the ETF would. But diversification and peace of mind come at a price!
Diversification
Yes, diversification is also a con of dividend ETFs. Why? Because you don’t want to be over-diversified either. Some people will tell you that doesn’t exist. Or that you can never own too many stocks. I say bullsh*t. Let me give you an example.
I’m currently up ~21% on my RioCan (REI.UN) position in a little under 2 years. I own it as an individual stock. If I had chosen to own this company within a real estate ETF instead, it’s highly likely that my return wouldn’t have been this high as there would have been other companies in the fund that may not have appreciated as much as RioCan has in the past couple of years. This becomes a larger issue when the fund you’re buying has 500+ stocks.
Some index fund investors right now are thinking to themselves “but what about Vanguard’s Total Stock Market Index Fund ETF (VTI)?”
Ya, owning the ENTIRE stock market (4124 companies to be exact) is a no-brainer way to participate in the gains of corporate America, but being that diversified comes at a price. Something to keep in mind.
How I structure my portfolio + a strategy to try out (reinvesting individual stock dividends into dividend ETFs)
This is 100% personal preference and a strategy that works for my own goals.
As a “dividend investor” the majority of my portfolio is made up of stocks that pay dividends (common sense right?). But I’ve always found it useful to own at least 1 dividend ETF. Why? Well, it allows you to own a basket of dividend-paying companies without the risk of owning just one. What I mean by this is if one of the companies in the ETF so happens to cut their dividend, the effect is minimal. If instead SmartCentres were to cut its dividend, then my dividend income would fall drastically. I enjoy the diversification as well as the decreased risk. It just helps me sleep at night.
When it comes to different investing strategies, I’m always testing out new ways of managing my portfolio. Something I’ve been doing lately is reinvesting my individual stock dividends into my dividend ETFs. The reasoning behind this is simple. I’m using money that wasn’t mine to begin with and sticking it into an ETF that allows me to spread that money across a variety of different companies that also pay dividends. You’re essentially ensuring capital preservation (and added diversification) of your dividends by using them to buy shares in ETFs. It’s like parking free money into a high-yielding savings account.
Of course reinvesting your dividends into the same company to then buy more shares and earn even more dividends the next time around is also an effective strategy, this is just something I’ve been testing out as I need to bulk up my core ETF positions and this has helped me accelerate the process of doing so.
Final Thoughts
I believe every dividend investor should have a mix of individual stocks and dividend ETFs. Diversification is needed, but participation in capital gains is also nice. I currently have 19 positions (individual and ETFs) and 9 of them pay dividends. Of those 9 dividend-paying investments, 1 of them is a dividend ETF. Although this may seem like very little, that one dividend ETF makes up close to 10% of my portfolio. That’s the foundation of my dividend portfolio, all of the other dividend-paying companies are just a bonus.
My suggestion: Build your core, then build around it.
NOTE: Scroll down to see a list of my favorite Dividend ETFs (Canadian + US)
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