Targeting dividend paying equities for long-term investing success

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Fisher Investments Canada knows that receiving steady dividend income is an attractive proposition for many equity investors. While a high dividend income stream is tempting, focusing on a dividend-centric portfolio could limit your long-term investing success. High dividend yielding equities can certainly be a part of a long-term retirement income plan, but over-emphasizing dividends could open your portfolio to unexpected risks.

Instead of strictly relying on dividend yielding equities, Fisher Investments Canada believes a more comprehensive approach which factors in total return – not just dividend payments – can improve the chances of reaching your long-term financial goals.

What exactly are dividends and how do they work?

A dividend is a voluntary distribution of earnings – or profit – from a company to shareholders. Mutual funds and exchange-traded funds (ETFs) also often pay dividends, but this is largely a function of the dividends they receive from companies these funds hold. Dividends are often paid out by companies in lieu of reinvesting earnings to fund long-term growth projects.

A company’s board of directors determines the amount and format – usually cash or additional shares – of a dividend. To be eligible for payment, shareholders must own the company’s shares prior to what’s called the ex-dividend date. The ex-dividend date, actual payment date and payment frequency can vary.

High dividend yielding equities are usually concentrated in certain sectors. For example, companies that tend to pay dividends are more prevalent in defensive- and value-heavy categories like utilities, financial services, health care and consumer staples. Growth companies, commonly in the tech sector, tend to reinvest earnings back into the company.

Sector Composition Differences

Fisher Investments Canada believes having a well-diversified portfolio is key to investing success. Investing in high dividend yielding equities alone means missing large swaths of the global equities market.

Exhibit 1 highlights the difference in sector composition of the MSCI World High Dividend Yield Index relative to the broader MSCI World Index. The MSCI World High Dividend Yield Index has much greater exposure to health care, consumer staples and utilities sectors. This comes at the expense of growth-oriented sectors like information technology and consumer discretionary.[i] Depending on how these sectors perform, the deviation can have adverse implications for your portfolio.

Exhibit 1. Comparing Sector Composition

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Do high dividend paying equities outperform in rocky markets?

Demand for high dividend paying equities can increase during flat or declining markets, as has been the case for the majority of 2022. As demonstrated in Exhibit 2, the MSCI World High Dividend Yield Index, more heavily exposed to defensive and value areas of the market, has broadly outperformed the MSCI World since January 1, 2022.[ii]

Exhibit 2: Comparing 2022 Performance

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However, high dividend yielding equities don’t always provide consistent protection to investors during bear markets. For example, during the 2007-2009 bear market that accompanied the global financial crisis, the MSCI World High Divided Yield Index fell 63.4 per cent – worse than the MSCI World’s drop of 57.8 per cent.[iii]

Notably, high dividend yielding equities have often lagged when growth categories lead the market. Exhibit 3 shows how the MSCI World High Dividend Yield has largely underperformed the MSCI World since the previous bear market bottom on March 23, 2020.[iv]

Exhibit 3: Performance since 2020 Bear Market

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While a defensive-heavy high dividend yield strategy could provide some outperformance in rocky markets, long-term investors should consider the risks of a dividend-reliant investment strategy. Fisher Investments Canada believes long-term investors are more likely to achieve their financial goals by investing in a well-diversified equity portfolio seeking to maximize total return.

Risks of chasing dividends

Some investors perceive dividends as the same as bond interest payments even though they are two fundamentally different things. Bond interest is earned by lending money to a borrower – whether that be a company or government – while dividends are capital being returned to shareholders.

When you purchase a share of a company, you are purchasing a sliver of that company’s liabilities and assets – including its cash. So when you receive a dividend from that company, you’re receiving something you have already paid for. This is why you usually see the equity share price adjust by roughly the same amount as the dividend on the ex-dividend date.

Another risk is that dividends aren’t guaranteed. Dividends can be canceled or suspended for any or no reason at all. In practice this doesn’t typically happen, but it can be one of the first actions a management team takes if the business falls on hard times. For example, in the months following the 2020 COVID-19 lockdowns, more US firms suspended or canceled dividends than in the past 10 years combined.[v] If you were relying on dividends for income, it could’ve proved costly.

A different approach to generating cash flow

Instead of focusing exclusively on dividend yielding equities, many investors may be better off investing for total return (capital appreciation plus dividends) and seeking alternative ways to generate income and cash flow. One often overlooked way to generate cash flow is to strategically sell shares and distribute the proceeds. At Fisher Investments Canada, we call this process “generating homegrown dividends.”

Strategically selling equities can also allow you to pare back holdings to help rebalance your portfolio allocation. It may also reduce the tax implications of generating cash, depending on your situation. By selectively selling equities to generate cash flow, you may be able to maintain a well-diversified portfolio with more flexibility than if you were relying solely on dividend income.

Fisher Investments Canada thinks investors who chase high dividend paying equities may be inadvertently taking on extra risks. The lack of guaranteed dividend payment and potentially reduced portfolio diversification are important factors long-term investors should consider when weighing high dividend paying equities. For some investors, creating their own cash flow via homegrown dividends may be a better, more flexible choice than relying on dividend income in retirement.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates. This document constitutes the general views of Fisher Investments Canada and should not be regarded as personalised investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments Canada will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.

Fisher Investments Management, LLC does business under this name in Ontario and Newfoundland & Labrador. In all other provinces, Fisher Asset Management, LLC does business as Fisher Investments Canada and as Fisher Investments.

This content was produced by Fisher Investments Canada. The Globe and Mail was not involved in its creation.