Rob Carrick
Income investors: If you do one thing to tweak your portfolio for 2015, make it a quality check on your dividend stocks.
Lots of people have shaved down their bond holdings and added dividend stocks in order to generate more income. It's a sound strategy on three conditions:
- You understand that even blue-chip dividend stocks can plunge in price, even as they keep paying dividend income.
- You have diversified your holdings and aren’t relying primarily on one sector, say the banks.
- Your holdings emphasize quality over yield.
On that final point, put an emphasis on lower-yielding dividend growth companies instead of high-yielding stocks. There's no set threshold at which a stock's dividend yield qualifies as high yield, but 5 per cent or thereabouts is probably a safe level to use. BCE Inc. had a yield a bit above 5 per cent for an extended period, although a surge this past fall took it below that level.
Stocks with higher yields are plentiful, but represent too much risk for investors who depend on investment income. That's a lesson that was reinforced late in 2014 by the dividend reduction at AGF Management Ltd., which ended up reducing cash payouts to shareholders by 70 per cent. AGF's yield had long been in the high single digits and at times edged into double digits. So tempting was that yield that at least one investing source ranked AGF as a Top 25 dividend stock.
Learn to read high yields as a warning, not a temptation. Yields climb as share prices fall, which means they're a clear signal of investor trepidation about a company. Investors aren't always right – some high yield stocks are quite capable of sustaining their dividend. But the risk of being wrong is significant, and not just in terms of a reduced dividend payout. When a company cuts its dividend, its shares are typically hammered.
High yield stocks offer more income in the short term, with more risk. Consider replacing them with dividend growth stocks, which tend to come with lower yields when you buy them. You're only compromising on yield in the short-term. Over the years, consistent dividend increases will push the yield on your upfront investment steadily higher. Yes, you can have quality and a high yield, too, if you're patient.
Rob Carrick