The article “Yield Matters So Here’s A Primer On High-Dividend-Paying Stock, Bond and ETF Options to Fund Your RRSP” was originally published on Financial Post on February 7, 2017.
Interest rates have stayed lower so much longer than most would have expected after the 2008 financial crisis. The U.S. Federal Reserve has begun raising interest rates, most recently a 0.25 per cent increase on Dec. 14. The Bank of Canada has not raised rates since June 2010 — and their last move was a rate decrease in July 2015.
Although Canadian interest rates may not rise in 2017, a surprising jobs report in December showed the Canadian labour market grew up by 53,700 jobs, compared to expectations of a 2,500 decline. This is a sign that Canadian rate hikes may be coming as the economy improves.
Further interest rate pressures may result from Trump’s inflationary policies and a sustained higher oil price. The Canada 30-year bond yield was well under 2 per cent for much of 2016 but rose significantly from 1.872 per cent on the day of the U.S. election to end the year an astounding 24 per cent higher.
In the meantime, what is an RRSP investor to do given the low-yield environment that still largely persists?
For conservative investors, the highest yielding Guaranteed Investment Certificate (GICs) are only yielding 2.10 per cent for a one-year GIC and 2.50 per cent for a five-year GIC currently. But do not expect to get these rates from your bank. Credit unions and online banks rule the GIC market these days due to their lower overhead costs.
Opening an account with a deposit broker may be the best option to build a GIC portfolio under one roof if you are worried about exceeding the $100,000 Canadian Deposit Insurance Corporation (CDIC) limits and need GICs from multiple issuers.
For stock investors, eighteen stocks listed on the Toronto Stock Exchange started 2017 with yields of more than 5 per cent. Most of them were preferred share and high-yield bond funds or real estate investment trusts (REITs), but stocks like Corus Entertainment Inc. Class B, Student Transportation and Transalta Renewables made the list.
Eight of the large cap stocks on the S&P/TSX 60 yielded exceeding 4 per cent, including three telecom companies (BCE, Shaw, Telus), two pipelines (Inter Pipeline, Pembina), two banks (CIBC, National Bank) and a financial holding company (Power Corp.).
Verizon is the only U.S. stock included in the Dow Jones Industrial Average’s largest 30 stocks yielding over 4 per cent, but the S&P 500 includes numerous juicy yields. If we exclude REITs, the companies paying over 5 per cent include Frontier Communications, CenturyLink, Seagate Technology, Mattel and Staples.
There are myriad exchange-traded funds (ETFs), mutual funds (passive and active) and money managers that have a focus on high-yielding dividend stocks like these.
Given that most of the 5 per cent+ yields on the TSX and S&P 500 are preferred share, high-yield bond and REIT funds, these sectors bear mentioning.
The S&P/TSX Preferred Share Index is comprised of preferred shares issued primarily by financial companies (65 per cent of the index currently). Preferred shares are similar to bonds, in that they pay a fixed, pre-determined dividend to investors. They are less volatile than common shares and tend not to rise and fall much in value under “normal” market conditions.
Despite a negative return over the 5 years ending Dec. 31, 2016, during an otherwise abnormal period where interest rates declined instead of rose, the current distribution yield is 4.68 per cent for this sector.
High-yield bonds are otherwise known as junk bonds, although that term may be a little harsh. These are bonds paying a high rate of interest because the issuers are of lesser credit quality than government and investment-grade corporate bonds.
On the downside, high-yield bonds are riskier and some of the companies that issue them are that much more likely to go to zero than a less risky issuer. On the upside, if the issuing company performs well and receives a credit rating upgrade or the economy performs well, high-yield bonds have the potential for price appreciation.
Historically, the default rate for high-yield bonds in the U.S. has been under 4 per cent over the past 30 years. In the 2009 recession, it peaked at around 14 per cent.
Investors have to be careful about buying individual high-yield bonds. There are plenty of ETFs, mutual funds and money managers that can offer diversification within this sector. The S&P 500 High Yield Corporate Bond Index currently has a yield to maturity of 6.03 per cent.
REITs are stocks that invest in real estate by either owning or financing investment properties. They are like mutual funds, in that they pool together several different investments (income-producing real estate or mortgages) into one investment.
You can buy individual REITs on the TSX or S&P 500 or you can buy ETFs or mutual funds that further pool together individual REITs that each own numerous underlying real estate investments for further diversification.
The S&P/TSX Capped REIT Index is made up of 16 stocks currently, representing the primary REITs within the Canadian market. The current distribution yield is 5.28 per cent.
I have noticed the private market seems to be providing a lot of supply of income-oriented investment products ranging from mortgage funds to factored receivables to private REITs. I highly recommend an exempt market dealer (EMD) when considering private market investments to help wade through the options. Notable investment frauds like the TIE Mortgage case in Alberta reinforce this need.
So why is yield so important?
If a 40-year old earns an 4 per cent rate of return on their $100,000 RRSP instead of 5 per cent, their RRSP will be 21 per cent smaller at age 65 — $266,584 instead of $338,635. And a 65-year old retiree would only be able to withdraw $32,006 per year instead of $35,476 per year from a $500,000 RRSP over a 25-year retirement if they only earn 4 per cent instead of 5 per cent – a 10 per cent difference.
If someone is over the age of 71 and has begun RRIF withdrawals, low yields mean they dip into capital given the required withdrawal schedule. Withdrawal rates may have declined in the 2015 federal budget, but there are still minimum withdrawals of 5.82 per cent at age 75, 6.82 per cent at age 80 and 8.51 per cent at age 85, effectively forcing a retiree to dig into their RRIF capital over time.
All that said, yield is just one part of the investment equation. If all you look at is yield, you may ignore other important considerations. Someone pursuing dividends at the expense of all else would have bought Nortel preferred shares right into the ground.
So consider this article a rudimentary summary of some of the income options available to you as an investor in a low yield world. Focus on the big picture though, whether considering individual investments or your overall financial planning.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto, Ontario.