ETFs - another view D R A F T Connolly Report White Page, Aug 1st 2016 ETFs, with exceptions, of course, have four fatal flaws: a lot of mediocre securities, too many holdings, not enough holding (the 'T' in ETF) and little or no increasing yield. In the total scheme of things, ETFs have not been around very long. Ben Graham wanted twenty years of continuous dividends before he purchased a stock. Few ETFs have a track record over a decade. ETFs are, however, being pyrrhically sold. The selling points hinge on low cost and the perceived safety of diversification. Financial planners love ETFs: they have an easy, believable pitch that generates recurring annual fees. • The biggest problem with ETFs is what's in the portfolio. The wrong sectors and the wrong stocks are often selected. Why? To keep up with benchmarks, managers have to play the quarterly earnings game. The average investor, for instance, has no idea of the differences between dividend stocks. Managers/marketers will pack the ETF with items (I hesitate to refer to them as securities) that provide high current income: high yield stocks. They want the fund’s yield to appear impressive. As with bonds, however, high yield stocks are usually junk. This being the case, and with high payout ratios, dividends are often not sustainable. When dividends are cut, prices fall and ETF investors suffer loss of income and loss of capital. Superior long-term results come from medium range yields and sustainable dividend growth individually held for the increasing income. CR Oct’13 • To truly build wealth, you have to build a portfolio yourself with individually selected dividend growth stocks. There are only a few dozen great Canadian dividend growth stocks. ETFs have too many mediocre stocks. Diversification does not eliminate risk. Correlations between asset classes are changing. Safety is more often in the price you pay, the quality of the company and the time held. • With the latest wave of ETFs, managers trade. It’s part of their name. Professionals think they can beat the market: most can’t. To create wealth, however, an investor must hold individual stocks to benefit from increasing yield and the growth of retained earnings. Rising cash flows drive capital growth and hence, most of the return: “the vast majority of long-term real return derives from equity income” (Dimson, Marsh and Stanton, LSE). Most people think it's capital gains. Some ETFs do not grow their distributions at all. Some do not even pass along all of the dividends paid by the companies. Actively managed ETFs also mean realized capital gains/taxes? And with trading (the 'T' in ETF) there is return souring re-balancing and year-end window dressing. To keep their jobs, managers must beat their benchmark. Individually run portfolios do not measure performance relatively. • Dividend growth investors obtain absolute results. Our objective is different: to increase retirement income each year. It's the cash flow that’s important. Hold for growing income. You do not obtain that with an ETF. With individually selected, superior dividend growth stocks you actually get wealthier as retirement progresses. Here are Metro’s annual dividends since 2000: 5¢, 6¢, 7¢, 9¢, .11, .13, .14, .15, .16, .18, .23, .26, .28, .32, .38, 45¢. It's easy to build a portfolio with individual dividend growth stocks. At the start, use the acronym TULF as a guide. Over a period of a few months, at least, select one of the major Telecoms; an electrical Utility; a Lower-yield, high-dividend-growth non-financial such as PJC, CNR or a food retailer; and finally a Financial. These securities perform better. Companies with recurring cash flow are the best and safest fit with retirement portfolios. For me it boils down to this: I'd rather have a growing income in retirement from quality, dividend-growing common stocks I’ve held for years, than liquidate capital straight away. It's safer not to depend on the vagaries of the market. Ask any accountant: capital gains are not income. © a Connolly Report White Page @ dividendgrowth.ca