Like F1 race cars, high dividend-yielding indexes have evolved

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Purchasing high dividend paying stocks is a lot like driving an old F1 race car. You select your stocks, like choosing a gear. Feeling the clutch, the manual gearbox and revving engine behind gives a sense of control.

But F1 cars have evolved. Transmissions are now semi-automatic, removing some of the drivers' work. As a result, the cars are faster. Dividend investors may wish to do likewise, with high dividend yielding indexes.

I understand the popularity of dividend stocks. Dividends represent real earnings. If a company can increase its cash payout each year, it signifies a healthy income and balance sheet. Such stocks are less likely to crash into a barrier. But predicting which dividend payers will perform can be a challenge. And watching for signs of a flat or cut dividend may not be worth the effort.

As a broad market index investor, I don't have to worry whether my stocks are increasing their dividends or not. Some do, some don't. By rebalancing my equities with bonds each year, I can ignore the stock market – spending more time with friends, family, or sports. Since Strategy Lab's inception, my stock indexes compare favourably against the individual dividend paying stocks carefully selected by my colleague, John Heinzl.

By Dec. 1, 2013, the equities in my indexing portfolio gained 24 per cent. Mr. Heinzl's stocks gained 17.17 per cent. This doesn't mean, however, that you should give up on dividend investing. The time comparison is short. Plus, plenty of evidence suggests that high dividend stocks outperform the market over time. It won't happen during every decade, but the long-term track record is strong.

Having said that, there's an easier way to buy these stocks. Like a modern F1 race car, you could skip the clutch and gear mashing, purchasing a couple of high dividend-yielding indexes through Vanguard or iShares.

The iShares Dow Jones Canada Select Dividend Index (XDV) comprises 30 of Canada's highest yielding stocks. It isn't especially cheap, costing 0.55 per cent per year. But it has performed well. From Strategy Lab's inception to Dec. 1, 2013, it gained 25.58 per cent including dividends, beating six out of the eight Canadian stocks in the Strategy Lab model dividend portfolio.

Only Bank of Montreal and Royal Bank stocks did better, and not by much. They gained 26.59 per cent and 26.35 per cent, respectively. Index funds, however, are relentless pursuers. During the first two weeks of December, the iShares Canada Select Dividend Index overtook the Bank of Montreal when its shares dropped 6.1 per cent. Picking index beating stocks isn't easy.

There's also the iShares S&P U.S. Dividend Growers Index (CUD) tracking American stocks that have increased their dividends for 20 consecutive years. It isn't cheap either, costing 0.68 per cent per year. Being hedged to the Canadian dollar is another downside, potentially costing an extra 1 per cent annually. But so far, its performance hasn't suffered. Mr. Heinzl's U.S. stocks gained 20.82 per cent; the dividend index was up 31.3 per cent.

Vanguard's entry into the high dividend yielding market has raised the bar by lowering costs. In November, 2012, the company introduced the FTSE Canadian High Dividend Yield Index (VDY). With 80 stocks, it's more diversified than its iShares counterpart, and it carries a lower expense ratio of just 0.35 per cent.

Vanguard also introduced a U.S. Dividend Appreciation Index (VGG) earlier this year. It charges just 0.28 per cent. Best of all, it isn't hedged.

Of course, I understand the thrill of picking your own dividend paying stocks. I would have a similar rush and preference for a sports car with an old-school manual transmission. But driving and investing are different. Investing should never be fun; such thrills are usually counterproductive. Choose the semi-automatic approach instead. You'll sleep better at night with a diversified portfolio of indexes, while freeing the greatest asset of all: your time.