After 30 years of investing I am questioning whether a portfolio should even contain Canadian dividend stocks. Over the past decade, I believe U.S. dividend exchange-traded funds have outperformed Canadian dividend ETFs. For example, according to my discount broker the U.S. Vanguard High Dividend Yield ETF (VYM) posted a 10-year return of about 81 per cent, more than double the gain of 37 per cent for the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY). Also, U.S. technology stocks have left both ETFs in the dust. Microsoft Corp. (MSFT), for example, has risen tenfold and Nvidia Corp. (NVDA) is up more than 15,000 per cent. While it’s true that Canadian dividend stocks benefit from favourable tax treatment, and Canadian investors are more familiar with these companies, I feel that the performance of U.S. stocks is so superior that perhaps there is no role for Canadian stocks any more. What are your thoughts?
I am all in favour of diversifying with U.S. ETFs or individual U.S. equities to increase your exposure to technology and other sectors that are underrepresented in Canada. That’s what I do in my personal portfolio and, to a lesser extent, in my model Yield Hog Dividend Growth Portfolio (view the model portfolio online at tgam.ca/dividend-growth).
But do I think you should abandon Canadian dividend stocks altogether? The answer is an unequivocal, all-caps NO!
For starters, the performance difference between the U.S. and Canadian dividend ETFs you cited is misleading. The returns do not include dividends, which handicaps the higher-yielding Canadian ETF.
If you include dividends, the Canadian ETF, VDY, posted a 10-year annualized total return (through Jan. 31) of slightly more than 8 per cent, or 116.5 per cent on a cumulative basis, according to Vanguard’s website. That compares with an annualized return of 9.9 per cent for VYM, or about 157 per cent cumulatively. So, yes, VYM has outperformed over the past decade, but it hasn’t doubled VDY’s return – not even close.
If you examine more recent time periods, however, the Canadian ETF comes out on top. VDY’s three- and five-year annualized total returns were 13.3 per cent and 10.1 per cent, respectively, compared with 10.7 per cent and 9.8 per cent for the U.S. ETF. All figures include dividends.
So it would be a mistake to punt Canadian stocks from your portfolio based on a belief that they are getting crushed by U.S. dividend stocks. They aren’t, at least based on the performance of these two Vanguard ETFs.
That said, you are correct that both Canadian and U.S. dividend-paying stocks have been getting trounced by Big Tech. Many technology stocks went straight up at the start of the pandemic, when people were spending more time on their computers and ordering more stuff online. Those stocks retreated as pandemic restrictions eased and interest rates rose, but they have been soaring again recently thanks to the boom in anything and everything related to artificial intelligence (no matter how tenuous the connection may be).
Does that mean you should put all or most of your portfolio into tech stocks? Again, the answer is a categorical no.
When a sector is in vogue, stock prices often get ahead of themselves. As an investor, the question you should be asking isn’t whether companies such as Microsoft (MSFT-Q) and Nvidia (NVDA-Q) will continue to grow – they absolutely will – but rather, whether their lofty stock prices are justified by their expected earnings growth rates. That’s a much tougher question, which analysts spend their days trying to answer with complex financial models that rely on assumptions about the future.
The danger with jumping into red-hot sectors with both feet is that, if reality doesn’t live up to expectations, you could get burned. Canada has seen its share of high-flying growth stocks that were market darlings before they fell off a cliff – BlackBerry Ltd. (BB-T), Shopify Inc. (SHOP-T) and Canopy Growth Corp. (WEED-T), to name a few.
I’m not saying a similar fate necessarily awaits any of the Magnificent Seven tech stocks, although Tesla Inc. (TSLA-Q) is already starting to make people nervous. With demand for electric cars softening, competition growing and the company cutting prices to keep its vehicles moving, Tesla’s shares have skidded about 20 per cent this year and are down by roughly half from their record high in 2021, when the company seemed unstoppable.
Now, it’s AI stocks that seem unstoppable. But if you want to build wealth and lower your risk, it’s advisable not to pick securities based solely on past performance or current hype. A better strategy is to build a well-diversified portfolio that gives you exposure to various sectors without making concentrated bets. Even a simple S&P 500 ETF will give you a hefty dose of technology stocks, with the Magnificent Seven – namely Microsoft, Nvidia, Tesla, Apple Inc. (AAPL-Q), Amazon.com Inc. (AMZN-Q), Meta Platforms Inc. (META-Q) and Alphabet Inc. (GOOG-Q; GOOGL-Q) – accounting for about 29 per cent of the index.
But even that is a little too much tech for some.
“The Mag 7′s rise has left the S&P 500 at around its most concentrated in at least the last 100 years. Perhaps not since the bubble of 1929 have so few stocks had such high weightings to the overall market,” Deutsche Bank analysts said in a research note this week, as reported by Investopedia. “In addition, no one quite knows how AI will pan out and who will win. … Tech changes rapidly over time. Current high valuations assume Mag 7 will always win.”
Canadian dividend stocks remain attractive for the growing income, tax benefits and capital gains potential they provide. Cutting them out of your portfolio would be a big mistake. While there’s no reason you can’t supplement your Canadian dividend holdings with U.S. stocks or ETFs, as with most things in life, moderation is the key.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
John Heinzl