A surprising source of dividend yields near 3%

An often overlooked benefit of investing in the Canadian stock market with index-tracking exchange-traded funds is a pretty good dividend yield.

Canadian stock-market indexes are dominated by dividend-paying blue chips. This explains why the indexes tracked by major Canadian equity ETFs offer dividend yields today that are very close to 3 per cent. Two quick examples: The iShares Core S&P/TSX Capped Composite Index ETF (XIC) has a trailing 12-month yield of 2.9 per cent, while the Vanguard FTSE Canada All Cap Index ETF (VCN) has a 12-month trailing yield of 2.8 per cent.

Just for context, five-year Government of Canada bonds yield about 1.5 per cent these days, while five-year guaranteed investment certificates top out around 2.8 per cent.

Both XIC and VCN distribute dividend income to investors on a quarterly basis, so they’re not as suitable as monthly-pay dividend ETFs for the income-focused investor. But if your investing goal is to build long-term wealth through total returns based on both dividends and share-price gains, a mainstream Canadian equity ETF delivers.

You also get dividend growth with these ETFs. XIC has increased the amount of eligible dividends (they get favourable tax treatment through the dividend tax credit in non-registered accounts) almost every year since inception. The total amount of eligible dividends per unit paid by XIC was 60.7 cents in 2016, 62 cents in 2017 and 69.5 cents in 2018.

Don’t expect the same dividend flow from U.S. equity ETFs. The Vanguard S&P 500 Index ETF (VFV) has a 12-month trailing dividend yield of just 1.7 per cent. The BMO MSCI EAFE Index ETF (ZEA) has a yield around 2.8 per cent, which tells you that international equity ETF yields are close to the Canadian level.

Enthusiasm for dividend investing often leads investors to stocks and funds that are heavily focused on particular sectors such as financials, utilities, pipelines and telecom stocks. But the examples of XIC and VCN show you can get a decent dividend yield and much superior diversification in a broad-market ETF as opposed to a dividend ETF.