Funding retirement with stocks with growing dividends

Vanguard’s Dividend Appreciation Index Fund gives you a diversified portfolio of stocks that have raised their dividends for at least 10 years in a row. It should go up with your need for income. Keep it in your RRSP to avoid US withholding taxes.

dividendsVanguard’s Dividend Appreciation Index Fund (NYSEARCA—VIG) remains a ‘buy’. You buy this ETF (Exchange-Traded Fund) on the New York Stock Exchange.

VIG owns 185 common stocks that have increased their dividends for a least 10 years in a row. It essentially buys the same numbers of the same stocks as NASDAQ’s US Dividend Achievers Select Index. VIG is doing a good job of tracking this index. In the six months to July 31, the ETF’s return came to 8.84 per cent. That’s very close to the index’s corresponding return of 8.87 per cent.

One reason why VIG earned almost as much as the index is because it keeps hammering down its costs. The ETF’s expense ratio is only 0.08 per cent. This is far below the expense ratios of its peers, which average 1.07 per cent. Paying lower expense ratios leaves more money in your pockets, of course.

You do pay a brokerage fee to buy VIG. But this is an investment that you can hold for decades. That’s because it automatically adjusts to buy new stocks that have raised their dividends for at least 10 years and to drop old ones that fall short. Over decades, one brokerage fee to buy becomes insignificant.

You can hold VIG for decades to come

Speculators try to buy stocks at the bottom and sell at the top. But as successful investor Bernard Baruch put it: “This can’t be done—except by liars.” Lots of market research backs up Mr. Baruch. Your wealth will reflect your time in the market rather than trying to time the market.

In order for you to hold through market cycles, you should stick to high-quality stocks. VIG’s stocks are generally of high quality. After all, you know that they’re doing at least well enough to continue to raise their dividends. In addition, the stocks’ median market cap is $55.8 billion. (A company’s market capitalization is the number of shares times the share price.) Big companies usually have more staying power than little companies. What’s known as ‘one-trick ponies’ are more likely to disappear.

VIG does more than just give you a diversified portfolio of US stocks. It also diversifies your overall stock holdings by giving you stocks that the Canadian market lacks or has in short supply. Industrials such as Key stocks FedEx Corp. and 3M Co. account for 31.7 per cent of VIG’s holdings. It holds 14.9 per cent in Consumer Services like Key stock Cardinal Health. VIG holds 14 per cent in Consumer Goods, like Key stock PepsiCo Inc. It holds 13.7 per cent in Health Care, like Key stocks Johnson & Johnson and Medtronic plc. VIG holds 8.7 per cent in Technology, like Key stock Microsoft Corp. And 4.8 per cent in Basic Materials, such as Key stocks PPG Industries. In contrast to the Canadian market, it holds no oil stocks and just 10 per cent in financials.

RRSPs avoid US withholding taxes

VIG currently yields two per cent. As the underlying stocks raise their dividends, so will the ETF. But we expect a rising price to keep its yield modest. The fact is, millions of baby-boomers are retiring each year. With low interest rates, many are turning to stocks that pay growing dividends. This will enable them to sustain their lifestyles in retirement. And growing dividends will give them some protection against the inexorable rise in the cost of living.

When you buy US stocks or ETFs in unregistered accounts your dividends will face a 15 per cent withholding tax. That is, you’ll receive only 85 cents for each dollar of dividends paid.

Payments to RRSPs (Registered Retirement Savings Plans), by contrast, are spared from withholding taxes. That’s why we advise you to keep Vanguard’s Dividend Appreciation Index Fund in your RRSP. While Vanguard offers similar funds in Canada, they yield less because withholding taxes get deducted.

Vanguard’s Dividend Appreciation Index Fund is a buy for decent and growing dividends as well as long-term fund price gains. But keep it in your Registered Retirement Savings Plan to avoid the 15 per cent withholding tax.

This is an edited version of an article that was originally published for subscribers in the October 20, 2017, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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