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Help! I can’t understand if I’ve made any money with my dividend-paying investments!

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dividend

Having difficulty understanding if you’ve made money with a dividend-paying investment?

So many investors look at their statement when it arrives and think:

I haven’t made any money! (Cue gnashing of teeth.)

But is it true?

Let’s say you hold investments that are of a dividend-paying nature. How do they operate?

Well, whether you’re investment is a mutual fund, an ETF or a stock, if it pays dividends, and you don’t really understand how dividends work, you’ll be confused.

Paid to wait

First, it’s important to separate your original investment from your dividend payments (distributions).

Dividend payments might be:

  • Monthly
  • Quarterly

or,

  • Yearly

Most dividends come in quarterly payments.

In this example, I’m going to use Royal Bank, a widely-held Canadian bank stock. It doesn’t matter what dividend-payer you use. It’s also the same with an ETF, a stock or a mutual fund. It’s only the terminology that changes (e.g. shareholder or unitholder).

Royal Bank pays a dividend of .63 cents quarterly. If you hold 100 shares of Royal Bank, you’ll receive a payment of approximately .63 cents four times per year per share.

Why “approximately”? Because depending on the health of the company, it may raise or lower the dividend. For example, Royal Bank raised it’s dividend payments this year. It’s first two dividend payments were .60 cents, and the last two were .63 cents.

To make things easy, let’s assume Royal Bank had made four dividend payments of .63 cents:

4 x .63 = 2.52

In my example, the dividend payment would be $2.52 per year. If the stock were valued at $62.00, that yearly dividend payment would be equal to 4.06 per cent (or one year’s dividend payments). Our example is very close to Royal Bank’s dividend yield (currently 3.94 per cent).

Let’s imagine the Royal Bank illustration above was a mutual fund. If the fund paid a dividend of $2.52, the dividend payment amount would be subtracted from the unit price each quarter.

Each time the dividend was paid (.63 cents), the unit price of the fund would be subtracted by the dividend payment.

Why?

But wait! Wasn’t there a dividend payment?

Because your Adjusted Cost Base (ACB) changes when dividends are paid out.  If the unit price of the fund did nothing, for example, ended the year at the same price it began it, your investment would look like it hadn’t made any money. Superficially, at least.

But it would have, because, when you receive the dividend, you get more shares / units. Your 100 original shares will increase in number.

Didn’t that fund pay $2.52 for the year? And wasn’t that payment supposed to be 4.06 per cent? And so, didn’t you, as an investor, make over 4 per cent on your investment?

Yes.

And every time the dividend was paid out, didn’t you get additional shares in your investment?

Yes.

But the four dividend payments, when made, count as dividend income if they’re held outside of a registered account. The dividend is reinvested into the fund. So, when your payment of .63 cents per share is made, for accounting purposes, it’s considered new money and a new investment.

In a future post, I’ll give you an example of what this looks like, and a key error less-experienced investors make in understanding their investments.

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Image: Flickr, Daily Dividend.

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Written by johnrondina

August 27, 2013 at 5:35 pm

Stocks, bonds and what? People need to learn more about investing

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Financial literacy or a pair of shoes?

Last year I blogged about financial literacy in Canada.

Statistics about kids and adults are a little worrying when it comes to financial literacy. From new data, Americans aren’t much different. Studies show people need to do a lot more to become financially knowledgeable.

Juggling the egg

I recently overheard this: “What’s in your portfolio?”

Blank stare, and then: “I own XYZ.” (One of the biggest stocks in the U.S.)

That’s it. XYZ. Nothing else.

But wait! XYZ’s done great! It should go up forever or even longer.

Hmmmm … The thing is:

Those are the two “it’s different this time” ideas that have humbled investors since stock markets were born. Short-term thinking … People forget that the XYZ’s of this world have been a long interchange of different companies throughout investing history.

Do you really want one egg dictating your financial future?

Investing without diversification is potential financial suicide. (Or at least financial Russian roulette.)

Momentum is a marvelous thing when it’s on your side. But your worst enemy when the tide changes.

Ask former RIM, Palm, Nortel, Enron, Lehman Brothers investors.

If this had been your only stock, how would you have felt? What would have happened to your portfolio?

Know what you know:

Find out what you don’t know

According to the Investor Education Foundation of the Financial Industry Regulatory Authority’s study in the U.S.:

  • 67 per cent rated their financial knowledge as “high”

but,

  • Only 53 per cent answered this question correctly:

True or false: Buying a single company’s stock usually provides a safer return than a stock mutual fund.

I doubt that most of these respondents were momentum traders trading single stocks. It’s more likely that the majority had no idea that this is one of the most important rules of wealth creation: Diversification.

  • Only 6% got the above question wrong, choosing “True.”

But,

  • 40% said they didn’t know the answer, and 1% declined to answer

Ouch.

Maybe it was just an anomaly.

Let’s try again:

If interest rates rise, what will typically happen to bond prices?

Rise? Fall? Stay the same?

No relationship?

  • Just 28 per cent answered correctly

Yes, they will usually fall.

  • 37 per cent didn’t know
  • 18 per cent said bond prices would rise if interest rates rise
  • 10 per cent said there’s no relationship between bond prices and interest rates
  • 5 per cent said bond prices would stay the same
  • 2 per cent said they preferred not to answer

Becoming a statistic can have long-term complications

Looking at these stats shows there’s a lot of financial illiteracy out there.

It’s a crime that financial literacy is not taught in high schools.

— Michael Finke, professor of personal financial planning at Texas Tech University/co-developer of the Financial Literacy Assessment Test, part of Ohio State University’s Consumer Finance Monthly survey.

(In Canada, things are changing.)

Can teachers help?

When asked about six personal financial planning concepts:

  • Fewer than 20 per cent of teachers and teachers-in-training said they felt “very competent” to teach those topics
  • Teachers felt least competent about saving and investing

   — 2009 survey of 1,200 K-12 teachers/prospective teachers National Endowment for Financial Education

What do you do if teachers don’t feel competent to teach financial literacy skills?

Governments …

  • Need to focus on helping teachers get these skills

or

  • Need to bring in outside help to assist in improving financial literacy skills

Agencies are doing their part in both the U.S. and Canada to raise awareness around financial literacy. They can’t do it alone:

  • Parents need to teach their kids about debt

But parents need to understand the dangers they’re trying to warn their kids about.

The consequences to our economy and economic future of financial illiteracy are immense. Championing long-lasting positive changes for kids (and adults) is important.

Those shoes were made for walking (but they could really cost you)

Study after study has shown that adults will spend more time focusing on buying a pair of shoes (or other purchase) than they will on their financial future.

Is this the legacy we want to leave our kids?

Find out more about diversification:

You don’t need to listen to Warren Buffett (if you’ve allocated your investment portfolio properly)

A simple way to arrive at the right asset allocation for your portfolio

Get the balance right

Plan like a pension fund manager when it comes to your investment portfolio

Asset allocation: Diversification is king

How to be a smarter investor

Part Two: You don’t need to listen to Warren Buffett* (if you’ve allocated your investment portfolio properly)

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In Part One of this post, I left off saying I’d discuss why having a plan benefits you when it comes to asset allocation within your portfolio.

Markets keep on moving

Investors have to be conscious of the fact that the markets are never static. No one knows exactly what’s going to happen in the markets.

Since markets change, and taking into consideration recent events, here are three points we should consider:

  • Are investors now overweight bonds?
  • Do investors miss out by trying to time the markets?
  • Can you achieve your investment/retirement goals by holding (supposedly) low-risk investments?

The bond blackhole 

It’s highly probable that some investors are overweight bonds. If this movement to bonds is related to short-term fear rather than long-term planning, it’s a mistake.

Consider an older retiree who’s heavy in bonds. That same retiree holding a large fixed income component in his portfolio is going to suffer in a bond correction.

Still, these older retirees need the safety fixed income investments provide them. But retired investors need to weigh the potential in equities long-term over the safety in bonds or GICs and allocate accordingly.

Equities, inflation and long-term hedges

Here’s an interesting article from The Economist discussing Canada’s pension plans.

Ask yourself: Why do professional pension fund managers include equities in their investments? Are they about to abandon stocks?

Without growth an investor’s going to be in trouble when they begin withdrawing investments in retirement. Equities have done best over the very long-term against inflation, even during recent superb bond outperformance.

So, what’s happened to stocks? Why all the noise?

Of course, it’s generated by abuses leading up to the financial crisis, and investors who’ve been spooked by the big correction of 2008-2009. But here’s the thing:

Stocks have undergone a period that will go down in history as one of the largest corrections most investors have seen. Equities then had a larger than average correction last year.

Since that time, if you’d focused on the opportunity presented, you’d have had some nice returns. Stocks may correct again since they’ve had a march upwards. Companies have increased dividends focusing on what looks like better times with strong balance sheets.

Are stocks a better value than bonds?

In Part One, you can find solid reasoning on why they are.

Don’t want to be glued to your portfolio?

What’s the easiest way to take advantage of market swings that favour different investments at different times — without becoming a burden on your personal time resources?

Proper asset allocation.

Despite the volatility, stocks have done pretty well

As the chart above shows, stocks and bonds have still done pretty well over the long-term. Amidst all the volatility, stocks and bonds have performed. U.S. stocks may not have done as well for Canadian investors, but they picked up enormously in 2011.

Avoiding equities? It’s going to cost you in the long-term

The S&P/TSX 60 is made up of sixty of the largest companies in Canada. These dividend-paying stocks have done well over the ten years above despite the correction during the financial crisis.

Since equities have had a couple of major corrections in the last five years, they continue to show value especially in the face of historically low interest rates. U.S. equities are showing even more value relative to those in Canada. But they’ve also had a nice increase lately.

Believe in your plan

The stock and bond markets have shown an amazing ability to outwit retail investors. It’s hard to know what the markets will do. Don’t worry about it.

The secret is focusing your energy in a pro-active plan:

That long-term plan will help keep you focused.

Do you still believe in your plan? Are you comfortable with the amount of risk your taking?

If you believe in your plan and you are comfortable with the amount of risk you’re exposed to, make sure you apply the following to your investment portfolio:

  • A well-balanced mix of suitable assets
  • Evaluate your portfolio regularly
  • Stick to your plan
  • Rebalance your portfolio
  • Diversify with respect to the assets you hold, as well as the geographies you hold them in
  • Contribute regularly to your plan in order to take advantage of market volatility

Stocks have a lot going for them at the moment, but they’ve had a great run over the last few months. Will they correct?

Bonds have performed very well since the financial crisis. Will they correct?

Whether there’s a market correction or not in either asset category isn’t important. What is important is that you have a long-term plan that takes advantage of outperformance at different times in both stocks and bonds.

A good manager will make use of market volatility.

So can you.

Need more information?

Click below for more about asset allocation and reallocation strategies:

Get the balance right

A simple way to arrive at the right asset allocation for your portfolio

Plan like a pension fund manager when it comes to your investment portfolio

Let’s think about assets

Asset allocation: Diversification is king

How’s Warren Buffett’s long-term stock-picking record?

Chart source: Globe Investor

 

*While using proper asset allocation may reduce your need to listen to Warren Buffett about the stock markets, listen to him, anyway. Few have been as successful as Buffett in stocks.

The title of my blog post is a poke at his critics. Even fewer of them have had the same long-term track record as Buffett!

The grand parade of future dividends

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“Increases dividend”: a sound byte that should be but isn’t cutting through the leaden bad news we’re surrounded by. Companies are raising their dividends, still, headlines are full of bad news coming out of Europe.

What should the average investor focus on? The parade of companies increasing their dividends, or the end of the world scenarios that continue to make headlines?

Here are some of the names increasing their dividends:

Disney, Chevron, GE, BCE, Ford (resumes paying dividend), Agrium, Enbridge, Iamgold (by 25 per cent), National Bank of Canada, Laurentian Bank … the list goes on.

Does this return of shareholder cash signal a more optimistic future? Shouldn’t we reward these companies with positive press for doing something that will contribute to shareholders and the economy ultimately?

Income-lovers jump on dividend-payers. Why?

When a company’s increasing dividends, and some have increased more than once this year, management’s saying, “Hey, our operations are strong enough to keep this dividend going for a long time.” Companies are careful about cutting dividends, and so, this makes them cautious about raising them.

When a company cuts its dividend, it becomes kind of a corporate leper. Confidence is lost. Reputation takes a whack. Investors run for the hills.

Because of this, most companies don’t trifle with raising their dividends. They do some hard forecasting before making increases.

The dividend parade continues

While people focus on bad news, opportunity sits there. Why do investors focus on daily bytes that create a horrorshow of headlines?

The bottom line is:

  • Corporations continue to pay shareholders
  • The news is what it is

Investors may have some suspicion regarding the business intelligence they get, but, are they to believe that the managements of all these corporations raising their dividends are so out-of-touch with the world economy that the opportunity these same managements see is misguided?

Fact over fiction

  • The U.S. economic news is improving
  • The S&P 500 is a bargain
  • So, too, is the S&P TSX 60
  • Historically-speaking, the markets look full of potential if you’re focused on dividend-payers that consistently grow their dividends
  • Dividend-payers allow you a margin of safety regarding a recession in Europe and what it might do to the markets while allowing the average investor the opportunity to participate in good news

While the future’s unwritten and it’s difficult to predict markets or economic activity consistently, following a diversified strategy brimming with dividend splashes is one that you can have some long-term confidence in.

Brian Wesbury of First Trust Advisors says, stocks are “the cheapest we’ve seen since early 2009 or the early 1980s … equities have priced in the end of the world.”

What happens if the world doesn’t end?

Share the wealth

Since I blogged about this back in December, there’s been a steady increase in dividends. Here are a few of the notable increases as companies continue to decide that their financial footing’s more than steady enough to give back to shareholders.

Surprise, surprise: BMO Scotiabank increase dividends

BCE profit climbs on strength in wireless, media (not to mention the dividend increase)

CN is the latest to increase dividend with management sounding confident about the Canadian economy

TD and RBC continue the grand parade of dividend hiking

JPMorgan raises dividend and buys back $15 billion in shares

Wells Fargo raises dividend and plans share buybacks over next two years

Apple finally issues dividend, but it’s puny

Goldman Sachs hikes dividend

Intel increases dividend, third time in last 18 months

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Written by johnrondina

December 16, 2011 at 1:34 pm

Wait a minute. There’s some good news re the markets?

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It’s all bad news, right?

Nope. Surprise, surprise. And it’s on the upside.

Pour this latest data into your glass and see if it looks half-full.

Panic and pessimism may usher in a market rise (It’s happened before. It’ll happen again.)

Contrarians love all the bad news. To them, it means we’re closer to good news as they wait for the point of maximum pessimism. But maybe we’ve already hit that point?

  • Inventory levels in the U.S. are low.
  • Stocks look cheap. Compare U.S. equities to U.S. bond yields. Dividends look great and promise more than bonds currently.
  • In the U.S., the fall in housing prices and low financing costs have created the most affordable housing climate in decades.

When could “mean” be green?

All things revert to a mean, don’t they? Usually, when someone says it’s different this time, it’s exactly the same as last time.

  • Bonds have beat the pants off stocks over the past 10 years. The last time equities were performing like this was the 1970s. Since this is true, bonds have become overvalued relative to stocks.
  • It’d be an understatement to mention that investors are increasingly risk averse. Panic is prevalent — especially in the news. In the face of this: Corporations continue to show financial strength and profitability. U.S. dividend payments continue to rise paying investors to wait.
  • The market went through the roof last week at an agreement to agree to agree in Europe. Looks like a ton of pent-up demand. The will for the markets to go higher is there. But investors who weren’t already in the markets had little chance to get in. Things just moved way too fast. Sitting on the sidelines may leave the average investor sitting on the sidelines.

What will be the impetus for markets to rise?

If governments stimulate again, we could see a big push in equity markets. There’s value in the markets. Stick to your plan.

Filter out the noise. Focus on the facts. Find the candles burning in the doom and gloom.

How many times have you heard someone say: I wish I’d bought shares in XYZ Corp.? Isn’t it funny that when companies are at big discounts, only the few and the brave want to go shopping?

When it comes to the markets, it’s often looked darkest before the dawn. But the facts above may be the lantern to help light your way.

Updates:

Prem Watsa of Fairfax Financial sees value in the market in the guise of RIM and doubles stake

Frank Mersch of Front Street Capital says stock market’s showing value and is cheap

Get the balance right

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Can we simplify asset allocation?

Yes, we can.

While there may be more to asset allocation than just stocks and bonds, stocks and bonds are the best starting points for most investors. Anyone can become an investor through mutual funds or ETFs.

What have most investors heard about stocks?

• Stocks usually outperform bonds over long periods of time

Ok, now, in this hypothetical, let’s imagine that stocks take longer than average for that outperformance to take place. What can we do to bolster our portfolios?

If we find ourselves in a period where equities take longer to outperform than average, we can arrive at two conclusions:

• Fixed income positions (bonds) are even more important

• Rebalancing is even more important

Why?

Because, although a 100 per cent portfolio of stocks should statistically outperform over the long-term, most investors are more human than they are instruments of logic. People are emotional.  Since they’re emotional, what is theoretically true about investing may not hold true in real life.

Volatility takes its toll. Big market drops herald big investor reactions. When bad news reaches a fever pitch about stock markets, many investors start to feel ill. Investors start abandoning strategy and discipline.

After all, there’s Europe, a potential recession, inflated house prices in Canada, and a blue sky that’s sure to fall. (Never mind that equities haven’t been this cheap in quite a while.)

The only things that have really changed are the names of the crises. Not to belittle the difficulties we face economically – these are challenging times – but we’ve always faced difficulties economically. With market corrections, and, with prudent planning, difficulties become opportunities.

Seeing the opportunity in today’s markets may be better than running around screaming the sky is falling.

If your portfolio has a good allocation to fixed income products – if you have a mix you’re comfortable with – and you have a disciplined rebalancing strategy, you should benefit. There are times when stocks and bonds move up or down at the same time, but usually, stocks and bonds move in opposite directions.

If your allocation is 65 per cent equity (stocks) and 35 per cent fixed income (bonds), then when your allocation drifts, let’s say to 70 per cent equity and 30 per cent fixed income, it’s time to rebalance.

What do you need to do? Sell some stocks and buy some bonds. Sell the asset class that has outperformed, and buy the asset class that has underperformed.

Sell high. Buy low.

Everyone knows that, right? But it takes great discipline to do. You have to automate the process.

Some investors worry that they’ll impede portfolio performance by selling stocks when they seem to be doing nothing but going up. True. This happens. Your allocation may change early in a bull market. But many investors struggle seeing future benefit in the face of the madness of crowds. The “noise” affects their focus and their resolve. It can make investors buy at the wrong time or sell at the wrong time. In down markets, too many investors only see current losses or declines.

What might be the best rebalancing schedule theoretically, may not work for the average investor struggling to cope with “noise” during a market correction, especially, if it’s a severe correction like 2008-2009.

While the financial crisis may have caused some grey hair, it was one of the best times in recent memory to test out your portfolio. Recent weeks also put some pressure on investor nerves while squeezing portfolio integrity.

It’s times like 2008 – 2009 that make people happy to own bonds. Bonds performed very well as stocks declined.  Stocks usually outperform bonds over the long-term, but bonds add some insurance to your portfolio.

As the market began the steepest part of its recent decline, we can see that bonds once again outperformed as investors positioned themselves for safety. The steady income from bonds and the hedge they provide against market drops often make them fund manager favourites.

Why should the average investor be any different?

Bonds providing a hedge during recent market correction

Part Two is here.

Part Two — Bonds: Why you should love the unloved investment

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Count bonds. Forget about sheep.

5-year chart comparing Canadian government bonds and the S&P/TSX 60

In the two years before the financial crisis, government bonds underperformed. Stock markets were hitting all-time highs and few investors were interested in bonds. However, as the risk premium for stocks was rising and stock indices in Canada and the U.S. were hitting highs, shrewd investors were reallocating their portfolios to include more bonds.

Bonds were unloved, but they were cheap, and when stock markets came down in a hurry, bonds acted like the buffers they are: they rose while stocks were coming down in portfolios.

The case for bonds in a portfolio as a permanent asset seems pretty solid. Let’s take a look at the last six months.

6-month chart comparing Canadian government bonds and the S&P TSX 60

Over the last six months, stocks have finally gone into a correction. Stocks have been incredibly buoyant since the bottom of the 2009 crisis and have performed very well. But corrections are a normal part of the investing landscape. Corrections are healthy since they clean out the speculative element in the market periodically. Investors, on the other hand, especially average investors, aren’t huge fans of volatility.

Looking at the chart over the last six months, we can see that government bonds turned up as the markets headed down. Bonds are doing what they do, once again: smoothing out returns by acting like insurance in your portfolio.

Equities hit home runs, but bonds keep you from crashing into the catcher’s mitt and getting called out at the plate.

Equities should outperform bonds in the next few years because bonds have made out well recently, but good diversification together with prudent asset allocation suggest the average investor should have some bonds in the asset mix. Recent news has shown us how commodities and stock markets can change direction in a hurry.

The debt situations in Europe and the U.S. illustrate the importance of having Canadian bonds in a diversified portfolio. Canadian bonds are in a good place when it comes to quality these days.  Just when many were saying Canadian bond returns had peaked and there was no future investing in them, boom, sovereign debt issues exploded in the media – again. Both recent history and the last few days are excellent reminders of why bonds have a place in the average investor’s portfolio.

Canadian government bonds may not work in a get-rich-quick scheme, yet when it comes to your portfolio, it pays to think. Think of bonds as insurance. Think of bonds before you go to sleep. In times of volatility, count bonds and forget about the sheep.

Part One is here.

Update: Foreign investors are also loving the unloved investment in Canada.

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