Dividend Investing: A Good Idea or a Huge Mistake?

One of the questions the Big Cajun Man asked me and the other panelists in a session at the 2013 Canadian Personal Finance Conference was whether dividend investing is a good idea. My answer was that while it is possible to do dividend investing well, few dividend investors invest well.

A common portfolio for Canadian dividend investors is one consisting primarily of Canadian big bank stocks. This is a very concentrated risk. To be invested entirely in Canada is bad enough, but to be invested in a single industry is worse. Who is to say that all the big banks will still be operating in 20 years? The downfall of Nortel was inconceivable 20 years before they declared bankruptcy.

The average investor should have stock investments spread across industries and countries. To be invested in Canada and the U.S. isn’t too bad, but it’s better to own some foreign stocks as well. One solution is to own some low-cost index ETFs of foreign stocks along with individual dividend stocks in Canada and the U.S.

Some analysts fear that the popularity of dividend investing has driven up prices making dividend stocks expensive right now. My crystal ball is permanently cloudy, but even if this is true, it is only a short-term concern. For investors planning to hold on for the long-term, short-term results are not the focus.

Many dividend investors try to beat the market by choosing superior dividend-paying stocks. Unfortunately, some blogs devoted to dividend investing offer hopelessly superficial dividend stock analyses to “help” this type of investor. The thundering herd of dividend investors can expect their stock-picking to be essentially random. When the stock picks are random, you need to own enough stocks to reduce volatility-induced losses.

One bright area for dividend investors is that by focusing on their fairly steady dividends and not the volatile stock prices, they tend to stick with their plans rather than selling out when stock prices drop. Investors who jump around from one hot stock fad to another repeatedly selling low and buying high can easily trail stock index returns by 5% per year or more. So, if a dividend investor is fairly well diversified and can expect to earn say 1% per year less than the stock indexes due to higher volatility, at least he or she isn’t losing 5% per year to manic strategy changes.

Overall, I still prefer to own low-cost stock index ETFs whose long-term performance will only trail the market return by less than 0.25% per year, but well-diversified buy-and-hold dividend investing isn’t too far behind.