Back in high school, having a party was a risky proposition. You never knew who might show up with a case of beer and a bad attitude.
I was reminded of this as I marked the sixth anniversary of my model Yield Hog Dividend Growth Portfolio. The party crasher this time wasn’t some drunk dude in a North Bay dinner jacket. It was rising interest rates.
Before I elaborate, some history is in order.
Back on Oct. 1, 2017, I launched the model dividend portfolio with $100,000 of virtual cash. As an income-oriented investor, my primary goal was to identify companies with a history of raising their dividends and a strong likelihood of continuing to do so. Any capital gains would be a bonus.
The money I used to start the model portfolio wasn’t real, but I follow the same dividend-growth strategy in my personal portfolio, which holds all of the same stocks (plus a few others). Knowing that reinvesting dividends is one of the keys to building wealth, I regularly redeploy cash to maximize the benefits of compounding. (Some investors prefer to make the process automatic with a dividend reinvestment plan, or DRIP, which is a fine strategy, but I like the control that manual reinvestment gives me.)
For the first several years, the model portfolio chugged along nicely. Companies raised their dividends regularly, and their share prices moved steadily higher, too.
But as the Bank of Canada began raising interest rates in 2022, the portfolio’s wheels started to wobble. This wasn’t a surprise, given that the portfolio includes many interest-sensitive stocks, such as utilities, power producers, pipelines and real estate investment trusts. These companies typically carry a lot of debt to finance their operations, so when borrowing costs rise, they feel the pinch. Rising interest rates also make bonds and guaranteed investment certificates more attractive, which means dividend yields have to rise to remain competitive. That causes share prices – which move in the opposite direction to yields – to fall.
While none of this was unexpected, what did come as a surprise was the speed and extent to which the Bank of Canada tightened monetary policy. With inflation surging to a 40-year high as the economy emerged from its pandemic slump, the central bank hiked its benchmark rate by a total of 4.75 percentage points over a period of just 16 months in an effort to cool the economy. The bank’s overnight lending rate now sits at five per cent – the highest in 22 years.
My dividend portfolio could only take so much of this medicine. After sinking by 6.8 per cent on a total return basis in 2022, the portfolio shrank by a further 4.3 per cent through the first nine months of 2023. That compares with a year-to-date total return of 3.4 per cent for the S&P/TSX Composite Index. (All total return figures include dividends.)
Thankfully, the news hasn’t been all gloomy. On a longer-term basis, the portfolio’s returns are still very much in the black. As of Oct. 1, the portfolio was valued at $137,793.73, representing a total return of about 37.8 per cent since inception six years ago. On an annualized basis, that works out to a return of about 5.5 per cent, which lags the annualized total return of about seven per cent for the S&P/TSX Composite Index over the same period.
What’s more, even as share prices have slumped recently, my model portfolio’s dividend income has continued to grow, consistent with its central mission. In September, for example, the utilities Fortis Inc. FTS-T and Emera Inc. EMA-T hiked their dividends, by 4.4 per cent and 4 per cent, respectively, joining a long list of other companies that raised their payouts this year.
When you add up all the dividend increases I’ve received in the past six years, the gains have been substantial. At inception, the portfolio was generating about $4,094 of income annually, based on dividend rates at the time. Now, thanks to scores of dividend increases and regular reinvestments of cash, the portfolio’s annualized income has grown to $7,237 – up almost 77 per cent.
But the benefits of rising dividends are more than financial. When your investment income is growing steadily, it’s easier to accept market volatility and sliding stock prices as normal parts of investing, without panicking and doing something rash.
That’s not to say the dividend growth strategy is perfect. As I’ve said many times, a portfolio composed strictly of dividend stocks doesn’t provide adequate diversification. I strongly recommend that investors supplement their blue-chip dividend holdings with broadly diversified exchange-traded funds that provide exposure to sectors such as information technology and commodities that aren’t typically associated with high or consistently growing dividends.
In my personal portfolio, for example, I also hold low-cost ETFs that track the S&P/TSX Composite Index and S&P 500. The latter has a weighting of about 28 per cent in technology stocks, including companies such as Nvidia Corp. NVDA-Q, Meta Platforms Inc. META-Q, Tesla Inc. TSLA-Q, Amazon.com Inc. AMZN-Q and Microsoft Corp. MSFT-Q, whose hefty gains this year have helped offset the declines in my interest-sensitive dividend payers.
When the portfolio’s next birthday comes around, perhaps interest rates will have peaked and I’ll have better news to share about dividend stock prices. But as long as my dividends keep rolling in, I’ll stay the course.
E-mail your questions to email@example.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.