All posts by Pat McKeough

Is a higher dividend yield better? Not Always. Learn how to spot the good from the bad to avoid this costly mistake.

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Investors Interested In Dividends Should Only Buy The Highest-Yielding Canadian Dividend Stocks If They Meet These Criteria—And Don’t Have These Risk Factors

Dividend yield is the percentage you get when you divide a company’s current yearly payment by its share price.

The best of the highest-yielding Canadian dividend stocks have a history of success

Follow our Successful Investor philosophy over long periods and we think you’ll likely achieve better-than-average investing results.

Our first rule tells you to buy high-quality, mostly dividend-paying stocks. These stocks have generally been succeeding in business for a decade or more, perhaps much longer. But in any case, they have shown that they have a durable business concept. They can wilt in economic and stock-market downturns, like any stock. But most thrive anew when the good times return, as they inevitably do.

Over long periods, you’ll probably find that a third of your stocks do about as well as you hoped, a third do better, and a third do worse. This is partly due to that random element in stock pricing that we’ve often mentioned. It also grows out of the proverbial “wisdom of the crowd.” The market makes pricing mistakes and continually reverses itself. But the collective opinion of all individuals buying and selling in the market eventually beats any single expert opinion.

Canadian dividend stocks and the dividend tax credit

Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

That means dividend income will be taxed at a lower rate than the same amount of interest income. Investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income. At the same time, investors in the highest tax bracket pay tax on capital gains at a rate of about 25%. Continue Reading…

Why this portfolio manager isn’t buying Bonds, and hasn’t for decades

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Recently a friend asked, “Pat, I see that several prominent Canadian investor advisors recently wrote articles that said it’s a bad time to buy bonds right now. Do you agree?”

He was surprised when I told him I haven’t bought any bonds for myself since the 1990s. I haven’t bought any for clients in the last couple of decades, except on client request.

In the 1990s, I used to buy “strip bonds” for myself and my clients, as RRSP and RRIF investments. This was the Golden Age of bond investing. Back then, high-quality bonds yielded almost as much, pre-tax, as the historical returns on stocks. In addition, they provided fixed income that simplified financial planning.

Bonds have tax disadvantages, of course. But you can neutralize those disadvantages by holding your bonds in RRSPs and other registered plans.

The big difference back then was that bond yields and interest rates were much higher than usual. That’s because we were still coming out of (or “cleaning up after,” you might say) the inflationary bulge of the 1970s and 1980s.

In the 1980s, government policies pushed up interest rates and took other measures to hobble inflation, and it worked. But interest rates stayed high for a long time after the government polices broke the back of inflation: kind of like finishing the antibiotic after the infection goes away.

High-quality stocks vastly superior to Bonds

Long-time readers know my general view on the stocks-versus-bonds dilemma. When interest rates are as low as they have been in recent decades, high-quality stocks on the whole are vastly superior to bonds. (See below for a further explanation). However, you have to understand the differences between the two. For one thing, stocks are more volatile than bonds. But volatility and safety are two different things.

Volatility refers to sharp price fluctuations, often due to short-term uncertainty and the randomness of short-term market movements. Safety refers to the risk of permanent loss. Continue Reading…

Why Canadian Small Caps should be a small part of your portfolio

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We think that small caps should not make up the bulk of your diversified portfolio — but you can benefit from making the best Canadian small cap stocks a smaller part of your holdings.

We generally feel that most investors should hold the bulk of their investment portfolios in conservative securities from well-established companies. This means holding a total of 15 to 25 well-established, dividend-paying stocks, chosen mainly from our “Average” or higher ratings, and spreading your holdings out across most if not all, of the five main economic sectors.

However, some investors choose to add more aggressive or speculative stocks to their holdings in their pursuit of bigger, faster gains. That can involve holding some of the best Canadian small stocks.

Understanding how we look at the best Canadian small cap stocks

We recommend a number of small-cap stocks in our Power Growth Investor newsletter, and we comment on others in our Inner Circle mailings, in response to questions by members. We also recommend some higher-risk investments in our Spinoffs & Takeovers publication.

Our Aggressive Growth Portfolio selections in The Successful Investor and Wall Street Stock Forecaster tend to be more highly leveraged and more volatile than our Conservative recommendations, and they can give you bigger gains and bigger losses. Their higher risk may be due to financial leverage, or to the risks facing their industry or particular situation. Still, our Aggressive Growth stocks are typically less aggressive than the picks in, say, our Power Growth Investor newsletter.

We can be wrong on any of our stock recommendations, of course. When we’re wrong on an aggressive stock, losses are likely to be larger than on a well-established stock.

Ultimately, the percentage of your portfolio that you should hold in either conservative or aggressive investments depends on your personal circumstances. An investor with a longer-time horizon or without the need for current income from a portfolio can afford to invest some money in aggressive stocks.

We look at many stocks before singling out our aggressive favourites, and we try to choose those with as much underlying value and as many hidden assets as possible. This is the best way to cut risk for conservative and aggressive investors, alike. Continue Reading…

How Real-Return Bonds compare to Regular Bonds

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ultimate guide to bonds

Real-return bonds pay a return adjusted for inflation. But when you buy a real-return bond, you are only protecting yourself against unanticipated rises in inflation.

Real-return bonds pay you a rate of return that’s adjusted for inflation, but that’s not always as promising as it seems.

When a real-return bond is issued, the level of the consumer price index (CPI) on that date is applied to the bond. After that, both the principal and interest payments are typically adjusted every six months, upwards or downwards from that base level, to compensate for a rise or fall in the CPI.

Look at this theoretical example to understand how a real-return bond works

The Bank of Canada issues $400 million of 30-year bonds maturing on December 1, 2049. The bonds have a coupon, or interest rate, of 2%.

If after six months from the date of issue, the new CPI level is, say, 1% above the level of the CPI on the issue date, then each $1,000 of bond principal is adjusted to $1,010 of bond principal ($1,000 x 1.01). The semi-annual interest payment is then $10.10 ($1,010 x 2% / 2).

If after 12 months, the level is 2% higher, then the bond principal is adjusted to $1,020 ($1,000 x 1.02), and the interest payment rises to $10.20 ($1,020 x 2% / 2).

Consider these three important factors to realize benefits with real-return bonds

  1. The price you pay for real-return bonds reflects the anticipated rate of inflation. In other words, if investors feel that inflation will rise 2% over the long term, the price of the bond will reflect that future inflation increase and its effect on the bond’s principal and interest payments. So, when you buy a real-return bond, you are only protecting yourself against unanticipated rises in inflation.
  2. When the inflation rate falls over a six-month period, the principal and interest payments of a real-return bond fall. In times of deflation, the inflation rate turns negative. In a prolonged period of deflation, the principal of a real-return bond could fall below the purchase price. Interest payments would fall, as well.
  3. As with regular bonds, holders of real-return bonds must pay tax on interest payments at the same rate as ordinary income. That income gets taxed at the investor’s marginal rate. In addition, holders of real-return bonds must also report the amount by which the inflation-adjusted principal rises each year, as interest income, even though you won’t receive that amount until the bond matures. That amount is added to the bond’s adjusted cost base.

If the CPI level falls, that reduces the inflation-adjusted principal. You deduct the amount of that reduction from your taxable interest income that year, and also subtract it from the adjusted cost base.

Download this free report to learn more about how to profit from stock investing.

Find out how real-return bonds compare to regular bonds and if they make better additions to your portfolio

In simple terms, a bond is a form of lending whereby you lend money to a corporation or government. In return, a bond pays a fixed rate of interest during its life. Eventually, a bond matures, and holders get the bond’s face value—but nothing more. Receiving the fixed interest and face value at maturity is the best that can happen. Note, though, that in some cases, corporate bonds can go into default. As well, inflation can devastate the purchasing power of bonds and other fixed-return investments.

Furthermore, bonds also generate more commission fees and income for your broker, compared to stocks, especially if you buy them via bond funds and other investment products. Continue Reading…

Short-term Investment Decisions can hurt your Long-Term Portfolio Returns

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While short-term investment decisions can look like the best way to profit in the stock market, we feel that a better strategy by far is to buy top-quality stocks: stocks that will gradually accumulate stock market profits over decades.

And because you’re investing for a long period of time, short market fluctuations will have very little effect on long-term gains. That makes for a less stressful term 30 (not to mention successful) investment strategy.

Short-term investment decisions can lead to premature selling

There is no denying the immediate appeal of taking a fast profit. However, most successful investors find over long periods that much of their profit comes from a handful of their best investments: stocks that went up much more than they ever expected. If you are too quick to take profits, you’ll wind up selling your best picks when they are just beginning to rise.

Even the best short-term investment decisions will cause you to miss out on the benefits of compounding

Compound interest — earning interest on interest — can have an enormous ballooning effect on the value of an investment over the long term, and lift the overall returns on your portfolio.

This compounding principle applies to equity investments like stocks, not just to fixed-return, interest-paying investments like bonds. When you earn a return on past returns (including reinvested dividends), the value of your investment will grow more quickly. Instead of rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate.

Additionally, you can’t expect to earn an outsized return on a risky investment in your portfolio indefinitely. Instead, focus on making steady gains over time with mostly conservative, dividend-paying stocks.

Making short-term investment decisions that cause you to miss out on big gains

To succeed as an investor, you need to get used to the idea that short-term declines come along unpredictably. And just as important, you need to be careful that those short-term fluctuations don’t prompt you to make ill-advised short-term investment decisions—decisions like getting out of the market in anticipation of a further decline and then missing out on a big rebound.

Before making short-term investment decisions, remember that the highest long-term returns will come from following our three-part Successful Investor approach

  1. Invest mainly in well-established, dividend-paying companies;
  2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities);
  3. Downplay or avoid stocks in the broker/media limelight.

Bonus tip: Short selling is one of the short-term investment decisions that we think will cost you money

Short selling stocks involves selling borrowed shares in hopes of a drop in price. We advise against this strategy, mainly because of the perennial drawbacks of short selling. Continue Reading…