When you’re looking at the yield of your portfolio, do you calculate the dividend as a percentage of the current market price or the initial purchase price?
The standard definition of yield is the annualized dividend payment divided by the current market price. For example, if a stock is trading at $50 and the dividend is 50 cents a quarter, or $2 annually, the yield would be $2 divided by $50, or 4 per cent.
But some investors also like to calculate their “yield on cost” by dividing the current annual dividend by the original purchase price. Continuing with the example above, say the investor purchased the stock several years ago when the share price was $25 and the annual dividend was $1. The yield on cost would be the current dividend of $2 divided by $25, or 8 per cent. The yield on cost is high because the dividend has doubled since the initial purchase.
If you want to calculate your yield on cost to illustrate the impact of dividend growth, that’s fine. But don’t make the mistake – as some investors do – of comparing the yield on cost of your stocks with the actual dividend yields in the marketplace. This is an apples-to-oranges comparison, because actual dividend yields are based on current stock prices, whereas yield on cost is based on a historical purchase price that no longer applies.
I have even known investors who are reluctant to sell a stock with a high yield on cost because they would never be able to find such a high yield in the market. This reasoning is fundamentally flawed. For the purposes of comparing yields, the price paid for a stock is irrelevant. What matters is how much it is worth today and how much income the stock is generating as a percentage of the current market price.
Has the tax-free savings account contribution limit for 2020 been established yet?
Yes. The federal government announced recently that the 2020 TFSA dollar limit is $6,000 – the same as in 2019 – but this should not have come as a surprise to anyone. The annual limit is indexed to inflation and rounded to the nearest $500. The limit was raised to $6,000 for 2019, up from $5,500 in 2018, but with inflation remaining subdued, it could be several more years before we see another increase.
Remember that TFSA contribution room is cumulative. For someone who has been eligible for the TFSA every year since it was introduced in 2009 but has yet to make a contribution, the maximum contribution for 2020 is $69,500.
Also keep in mind that, if you make a TFSA withdrawal, you can add the amount back to your contribution room – but not until Jan. 1 of the year after the withdrawal.
What do you do when one stock becomes seriously oversized within your portfolio? I usually sell it down to a more balanced amount, but people have told me I should let the winners run.
It depends on what you mean by “seriously oversized." My own rule of thumb is to aim for an initial weighting of no more than 5 per cent of the total equity portfolio, but I’ll let that number creep higher as long as the outlook for the company remains positive.
How much higher? Well, if a stock rises to the point that it accounts for, say, 10 per cent or more of your equity portfolio, trimming would probably be prudent. Cutting back will limit the damage should the company’s fortunes take a negative turn. It will also limit the gains if the stock continues to rise, of course, but it’s all about controlling risk. I picked 10 per cent because it’s a nice, round number; you might wish to trim before the weighting gets that high.
Taxes are another consideration. If you hold a stock in your non-registered account and selling would trigger a hefty capital gains tax hit, you might want to give it a little more slack than you otherwise would – again, as long as the company remains healthy.
The bottom line is that the decision to trim your position depends on how large the weighting is, your conviction about the company’s prospects and the tax consequences of selling.
E-mail your questions to jheinzl@globeandmail.com.
John Heinzl