Contrarian investment strategy is investingin contrast to the prevailing sentiment of the time. A contrarian investor believes that certain crowd behavior among investors can lead to opportunities in securities markets.
In an article from The Canadian Press entitled “Dividend stocks protect against inflation.” A portfolio manager cited in the article tells us that high dividend stocks are the alternative of choice for investors seeking regular income in an environment of low interest rates on guaranteed investment certificates (GICs) and securities. government bonds. They would even offer protection against inflation, precisely because of their high yield.
The case for high-dividend stocks is intuitively appealing: Dividends paid by publicly traded companies are a generally stable source of income despite turmoil in the markets and the economy. For anyone looking to earn regular income from their portfolio, dividend stocks therefore seem to be a good solution.
But now, if you compare it to the recent index earnings of the past 13 years they seems to be less rewarding.
It’s the total return that matters
Or is it? Some investors prefer stable income and others prefer growth and can handle some volatility.
First myth to be debunked: It is the total return of the equity portfolio that matters to an investor, even an investor seeking income. This return is made up in part of the dividends paid by the companies, but also and above all of the appreciation in the price of their shares on the stock market. Thus, by betting too much on dividends, there is a strong risk of achieving a lower return, either by excluding from the portfolio high-growth companies whose shares go up on the stock market (Tesla and Shopify do not pay dividends!) Or even worse, by excluding from the portfolio buying shares of companies unable to maintain their dividend in the medium to long term.
Inflation protection?
The argument that dividend stocks offer better protection against inflation is also questionable, to say the least. This is because high-dividend-paying stocks are more sensitive to changes in interest rates, since these companies often have a higher debt ratio, which hurts their bottom line when interest rates rise. Investors also tend to move away from them to buy bonds when rates rise, causing their prices to fall. Since inflation is usually accompanied by rising interest rates, it is better to bet on common stocks than on those with high dividends.
Taxes and fees
As we know, taxes and fees eat up a significant portion of returns and therefore of investor net income. Here, too, dividend-paying stocks are at a disadvantage. On the one hand, dividends are often more taxed than capital gains when paid into a non-registered account. On the other hand, a portfolio of dividend-paying stocks requires active management (to replace stocks that no longer meet the selection criteria) which forces the fund to realize its earnings and its holders to include them in their taxable income. Common stocks, in contrast, pay less taxable dividends and require no active management, which allows taxable gains to be deferred often for decades.
Active management of a dividend fund also results in higher fees (0.22% for XEI versus 0.06% for XIC) which weigh on investor returns.
What about bonds?
GICs and bonds do not offer protection against inflation. If inflation persists at current levels, its holders will effectively realize negative forward yields after inflation. However, we should not sell our bonds to invest everything in stocks – dividend or not. Rather, the role of bonds is to offer protection against the other big risk: disinflation or its first cousin, deflation. And the current yield on a bond portfolio – including a reasonable portion of corporate bonds – compares favorably with dividends on a common stock portfolio, at about 2.8%.
In summary
If you are looking to optimize the return on your portfolio after fees and after taxes – whether to generate retirement income or to grow your capital over the long term – bet on a good mix of common stocks of all capitalizations and quality bonds. These 2 asset classes are accessible in low-cost ETFs. When making a withdrawal from your portfolio, all you have to do is liquidate a portion of your ETFs in order to generate the required liquidity and get closer to your target allocation.
