How to add dividend ETFs to a Couch Potato portfolio

Mike wants to increase yield on his couch potato portfolio by adding dividend ETFs. Here’s what he should consider

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dividend ETFs

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Q: I am a 63-year-old retired Couch Potato investor. I haven’t seen any unbiased information about dividend ETFs. Have you got any thoughts or recommendations on these?

— Mike

A: The traditional Couch Potato portfolios use plain-vanilla index funds and ETFs that cover the broad market, without specifically focusing on dividend-paying stocks. Many investors wonder about modifying this approach by using specialized ETFs that focus on yield. This is an especially common question for retired investors who rely on their portfolio to generate income.

Whether a dividend strategy can be expected to deliver higher returns than the traditional Couch Potato is debatable, but I recognize the intuitive appeal of investing for income. If you decide to modify the strategy to focus on dividends, I’ll make a couple of recommendations.

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The first is to make sure you stay well diversified. The broad-market index funds in the Couch Potato lineup include hundreds, even thousands of stocks. ETFs that screen for companies paying higher-than-average dividends will inevitably include fewer names, and some include just 30 or so. Moreover, the stocks may be concentrated in a small number of sectors. Some Canadian dividend ETFs have more than 60% of their holdings in banks and financials, for example. It’s certainly possible to build a diversified portfolio with dividend ETFs, but it’s harder, and you may have to use several funds with different strategies to avoid overlap.

The second key issue is to keep an eye on taxes. While eligible dividends from Canadian companies are tax-favoured (especially if you’re in a low tax bracket), not all high-yield ETFs have that advantage. Dividends from U.S. and international stocks are fully taxable as income and may be subject to additional foreign withholding taxes. Real-estate investment trusts (REITs) are popular with yield-oriented investors, but the income from these stocks are generally not characterized as dividends and are also fully taxable.

Even if you are using your portfolio to generate cash flow in retirement, it’s not necessary to modify the Couch Potato strategy to focus on dividends. For more on how to use a “total return” approach, see A better way to generate retirement income.

Dan Bortolotti, CFP, CIM, associate portfolio manager with PWL Capital in Toronto

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One comment on “How to add dividend ETFs to a Couch Potato portfolio

  1. As an admitted anti-mutual fund guy, I have often suggested to family and friends who have no time nor the inclination to dive into the world of investing that they consider ETFs and have steered them to MoneySense and Dan’s Couch Potato site and articles. Dan provides an excellent investment strategy for those looking for a low amount of time and effort. and I dare say, for the rest of us well. However, I often read investment articles and it appears they are geared for middle to high net worth individuals. For example, I would guess that a substantial number of Canadians do not have $600,000 in non-registered accounts to invest. While reading this article, this made me think “Am I missing something”? It is more likely a lot of people have retirement savings in a RRSP and right now, I believe the maximum contribution room for TFSAs is up to over $50,000. For registered accounts Dan’s strategies certainly apply, but his concerns about taxation don’t all apply. Yes, you have to pay income tax on RRSP or RRIF withdrawals, but dividend and capital tax gains taxes are not in the picture. Also, if one has savings outside of his or her RRSP/RRIF, they can put as much as $52,000 in a TFSA from which even withdrawals are not taxed. After all, it is called “Tax Free”.

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