Two ETF strategies to help inflation proof your investment income. Part 1.

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PART 1: Dividend Growers

A colleague recently raised a very good question. How do I invest so that my income keeps up with inflation? We are all living much longer and we need to develop investing strategies that will provide cost of living adjusted income for 20, 30 years or more. With inflation at even a modest 2% per year, after 20 years a current dollar will be worth $.52, and after 30 years $.19. That is pretty frightening.
Luckily, there are some solutions in the form of relatively low-cost Exchange Traded Funds (ETFs). The first solution, is what is known as the “Dividend Grower” ETFs. These funds invest in companies with a proven track record of growing their dividend payouts each year. They pay a dividend of around 4% annually at the current values. Importantly, according to Standard and Poors (S&P):
“In addition to being a source of income, dividend growers have historically provided higher price return performance because of their exposure to quality characteristics that can help cushion against market volatility”.
S&P, March, 2018

It seems likely that we are in a period of heightened volatility for the Canadian economy and therefore, Canadian stock markets. So caution is highly advised. On the other hand, the tax treatment of Canadian sourced dividends is so favourable that they are hard to ignore. As the following table indicates, an investor in Ontario can receive taxable income of up to C$46,000 and pay 0% tax on dividend income (actually, the tax rate is negative between $25,000 and $46,000). Even up to C$75,000 taxable income, the tax rate on dividends in Ontario is 9%. Compare that to the alternatives:

Income Bracket             Tax %    Int     Div     CapGains
19000-25000                                      70       62         35
25000-36000                                      20        -7         10
36000-46000                                      23        -4         12
46000-75000                                      33          9         17
75000-85000                                      44         30        22
85000-121000                                    52         41        26
121000-142000                                  43         25        22
142000-203000                                  48         32        24
203000+                                              54         39        27

In Canada, there are a number of Dividend Grower ETFs to choose from. The following are the currently available options:

CDZ (IShares)                  MER   .66%    Yield   3.8%

XDV (IShares)                 MER   .55%     Yield   4%

VDY (Vanguard)             MER   .22%     Yield   3.8%

ZDV (BMO)                      MER   .39%      Yield   4.75%

XDIX (IShares)               MER   .11%       Yield    4.8%

PDC (PowerShares)       MER   .55%       Yield    4.9%

MER = Management Expense Ratio, the amount that the fund company charges for managing the ETF.

Note that a number of these ETFs have a large component of financial stocks, so if you already own, for example, Canadian Banks in your portfolio, you have to be concerned about over concentrating your holdings in financials. The following graph shows the relative performance (excluding dividends) of four of the largest Dividend ETFs over five years:





Rob Carrick, the Personal Finance writer for the Globe and Mail, produces his annual ETF Buyers Guide. You can read Rob’s excellent analysis of Dividend ETFs here:

Note: currently accessible only to Globe subscribers. Working on getting full access to the report.

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