# Index funds (couch potato) and distributions



## bean438 (Jul 18, 2009)

I read a bit on couch potato investing. Sounds like a stress free way that should outperform most actively managed funds.

I have a few questions.

1. Dividends... obviously indexes have dividend paying stocks in them. How does that work? Are dividends simply reinvested in new units of the fund as they are received?

2. Witholding taxes. In a TFSA I know canadian dividends are fine. Us dividends will be witheld at 30%, and "foreign" witheld at whatever rate the hosting country determines.

Personally I have an existing TFSA with 2 stocks, BMO and PWF, purchased luckily in march. Yield on cost is 10.2% along with a handsome capital gain. No reason to change that as I enjoy a market beating return on dividends alone , and hopefully a capital gain that moves in tandem long term with the dividend increases. I also enjoy a huge margin of safety.

I was thinking of opening a TD e series TFSA for next year, split 3 ways: CDN equity, US equity, and MSCI EAFA equity, all currency neutral. Skip the bond component.
Auto pilot bi weekly contributions, split 3 ways year after year, taking advantage of DCA.

Current RSP, LIRA are 100% stocks with a long history of dividend increases.

I will be implementing the smith maneuver soon and will try the monthly DCA method via "actively" managed funds.

All methods of investing have pros/cons and all can provide statistics supporting their own superiority while "bashing" other styles.

Personally I think everything works, but not everything works all the time. The main thing is to pick something and stick with it. Value works but not in "good times". If you are value and jump ship when "its different this time" you will miss the value train.

I know what i want to do kind of runs contrary to that, but I read the Dick Davis Dividend and everything seems to work, even actively managed funds so long as you focus more on the actual manager rather than the fund.

Basically I will have 3 styles.

1. Buy and hold dividend growers in my RSP/LIRA existing TFSA
2. Buy and hold DCA indexing in new TFSA
3. Buy and hold DCA active management in the SM.

I will not jump ship and will keep the course with each account.

In 20 years I will post back and let you all know what REALLY works! 

Not sure why I posted this but I would encourage any comments, input, etc.


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## DAvid (Apr 3, 2009)

"I read a bit on couch potato investing. Sounds like a stress free way that should outperform most actively managed funds."

Not necessarily. Canadian Capitalist's Mini Sleepy Portfolio has not exceeded it's capitalization since inception in September 2007. Every quarter has seen a loss. There were managed funds which outperformed it.

http://www.canadiancapitalist.com/sleepy-mini-portfolio-q2-2009-update/#more-2484


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## CanadianCapitalist (Mar 31, 2009)

DAvid said:


> "I read a bit on couch potato investing. Sounds like a stress free way that should outperform most actively managed funds."
> 
> Not necessarily. Canadian Capitalist's Mini Sleepy Portfolio has not exceeded it's capitalization since inception in September 2007. Every quarter has seen a loss. There were managed funds which outperformed it.
> 
> http://www.canadiancapitalist.com/sleepy-mini-portfolio-q2-2009-update/#more-2484


I'll have to clarify that the Sleepy Mini Portfolio was started at the peak of the bull market in August 2007. As of yesterday, the market value of Sleepy Mini is down 3% from book value. I don't think that's too bad considering the market is still 20% below the August 2007 level. 

I'll be very surprised if the portfolio doesn't outperform the vast majority of mutual funds consistently. I'd like to know which managed funds picked in advance outperformed the Sleepy Portfolio (or similar couch potato portfolios) consistently.

In hindsight, it is easy to see some funds outperforming index portfolios. It is picking the market beaters in advance consistently that is impossible.


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## leslie (May 25, 2009)

bean438 said:


> Yield on cost is 10.2% along with a handsome capital gain. I enjoy a market beating return on dividends alone.


 Hate to tell you but you are deluding yourself with that calculation. The yield you get is no different from the yield everyone else is getting. Go through the exhaustive explanation.

Yields/returns are calculated as distributions/profits over a period of time divided by cost at the beginning of that period. The 10.2% you quote is not the income you earned last year, or the cululative return since you bought it, or the income you will earn in the next year. It represents nothing really.....


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## bean438 (Jul 18, 2009)

Leslie, I dont understand. My yield is different than everyone else because we pay different prices. My % was overstated. It is actually 9.6%

My stocks cost me 4719.47. I receive yearly dividends of 460.60, giving me a yield of 9.7.
I agree it is not cumulative return. I have a capital gain around 83% as of today PLUS my dividends.

I bought the stocks for their income. How can this all mean nothing? My friend who bought a 5 year GIC for his TFSA earns him far less income, and it is still worth 5K. In 5 years it will still be worth 5k.

My dividends will likely increase over the next 5 years, as will the stock price.

This means nothing? I am quite happy. I dont see a flaw in the yield on cost methodology. Jerremy Seigel will back me up. I am not sure who the shaw.ca guy is.

CC, if I had started a TFSA in 07 at the peak, but DCA'd every 2 weeks into a couch potato portfolio, not paying attention to the news, and how the end of the world is near, and the economy will collapse, etc, I am sure I would be further ahead over a bulk purchase. Sounds pretty stress free to me.

If you had started your sleepy portfolio in March 09, you would be in a different situation.

Bulk purchase is dependant on when you do it. DCA makes it easier and less emotional.


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## bean438 (Jul 18, 2009)

yield on cost:


http://www.dividendgrowthinvestor.com/2009/02/yield-on-cost-matters.html

http://www.dividends4life.com/2007/11/yield-on-cost.html


http://www.investopedia.com/terms/y/yield.asp


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## DAvid (Apr 3, 2009)

Canadian Capitalist said:"As of yesterday, the market value of Sleepy Mini is down 3% from book value. I don't think that's too bad considering the market is still 20% below the August 2007 level."

But does that include the purchases you made during the fall in value? In other words, are you comparing the sleepy portfolio as you have managed it, or has the book value of your original purchase volumes returned to their August 2007 level? It's not accurate to compare a portfolio which has regular cash infusions to it to the market which has had no such infusions.

Heck, had I bought $10,000 of TCK on March 9, I'd see my portfolio well above the August 2007 valuations!

Lets be sure we are comparing apples here!


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## bean438 (Jul 18, 2009)

DCA vis index funds should do ok long term. The only negative i can see is that you are "living off the pile" when you retire. If we happen to have a long bear market, or very long range bound market you are selling units at a low price for cashflow.

Ideally there would be a severe 20 year bearmarket/rangebound market until you retire and then a massive bull market until you die.


This is where I believe the dividend growth strategy wins. You build your portfolio over time, and live off the dividends, not worrying about prices.


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## CanadianCapitalist (Mar 31, 2009)

DAvid said:


> Canadian Capitalist said:"As of yesterday, the market value of Sleepy Mini is down 3% from book value. I don't think that's too bad considering the market is still 20% below the August 2007 level."
> 
> But does that include the purchases you made during the fall in value? In other words, are you comparing the sleepy portfolio as you have managed it, or has the book value of your original purchase volumes returned to their August 2007 level? It's not accurate to compare a portfolio which has regular cash infusions to it to the market which has had no such infusions.
> 
> ...


Fair enough. Let us compare the Sleepy Mini Portfolio to the average cost of just the TD Index fund with regular infusions. The index is down 6% from the book value counting cash infusions done at the same time as the Sleepy Portfolio. As noted in the previous response, the Sleepy Mini Portfolio is down 3% from its book value.

Even this information isn't very useful. As the Sleepy Portfolio is diversified, you expect it to have lower volatility than the index.

But my question remains: which fund picked in advance beat the Sleepy Portfolio? It is not enough that looking back we find funds that beat the index. Of course, there will be winners. It is picking them in advance that is the trick. 

I'm willing to compare performance going forward. The Sleepy Mini Portfolio gets a $1,000 infusion every 3 months on the last business day of Feb, May, Aug and Nov. I'd be happy to track performance of active funds picked in advance and compare it to Sleepy Portfolio performance.


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## DAvid (Apr 3, 2009)

Why not just do a comparison without the infusions? It would then be easier to compare across funds. 

However, you have addressed my question -- the sleepy mini portfolio is down 3% with your cash infusions and the TD fund of your choosing is down 6%, not the 20 % you originally compared the sleepy mini with. I'm now satisfied we're looking at more valid comparisons, and can more readily accept your position.


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## leslie (May 25, 2009)

bean438 said:


> I dont understand. My yield is different than everyone else because we pay different prices.


But you make no effort to figure out "What does the metric (future div / historical cost) measure?" You only admit it does not measure cumulative return. But neither does it measure your past year's return, nor does it measure your prospective year's return (like the normal dividend yield calc does and against which it is compared). 

Nor did you attempt to explain away the reality that if I had
* bought exactly when you did when you did, but 
* sold the shares by mistake this morning, and so
* bought them back right away for the same value,...

....I would 
* have earned exactly the same return-to-date as you,
* have exactly the same go-forward prospects as you,
* but be disqualified from claiming the huge yield % that you think you can claim.

I say the METRIC measures nothing and means nothing. I never said 
* equity returns won't outperform GICs or that
* dividends do not increase or that 
* capital gains do not exist.

The metric is only an dilusion that makes you feel like you are accomplishing something special.


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## bean438 (Jul 18, 2009)

Leslie I still do not understand your point. You are complicating things. 
If I invest x amount of dollars and receive x amount in the form of dividends then my return, income, yield is x. That does not change.


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## leslie (May 25, 2009)

It is not complicated. The metric you are using is delusional and measures nothing and means nothing.

Your calculation of returns/yields is not correct. As I said above the calculation of ANY yield or rate of return is:
*The distributions/profits over a period of time divided by cost at the beginning of that period.*

And you have still not said what you think the metric measures. Your past year's return, your cumulative return since purchase, or your future yearly return (which I would state as the published normal dividend yield calculation).

And you have not explained why you think YOU can claim an humungus yield % while I cannot just because I sold and repurchasing the stock this morning ... even though we have exactly the same reality, past, present and future.


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## bean438 (Jul 18, 2009)

I can clain the yield because it is what it is. 
What don't you understand?

If I were to sell and rebuy I would now be getting a much lower yield based on a higher invested amount. 

Totally different. For me the end result is the same but for some one else investing the same amount at todays yield would be lower. 

If my stocks dropped to the price I paid my yield would be the same. 

I invest 4700 and get. 460 a year. 9.2%. Forget yield on cost. Let's call it yield on the initial amount invested. 

Let's call it a "fluctuating equity bond". In mar 09 my "bond" pays 9.2% with the potential for capital gain loss. 

Anyway let's get back on course here.


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## Mockingbird (Apr 29, 2009)

Bean438 & Leslie-

I believe both are talking about two different issues and both are correct – just the terminology differences. Bean438 is talking about the “investment” yield and Leslie is talking about the “dividend” yield.

Investment yield is strictly a return on the initial investment (for a specific time period). Bean438 calculated in terms of simple interest. He did say, _yield on cost_, not yield on dividend. Perhaps the usage was a bit misleading, but I understood what he was trying to convey. 

Dividend yield is exactly what Leslie described. It is an amount, in terms of percentage, that gets paid out in relative to the “current” stock price.


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## bean438 (Jul 18, 2009)

Thank you Mockingbird. I often know what I want to say in my head but cannot convey in writing.

Investment yield on initial invested capital will always be the same.
Total return will also depend on capital gain or loss.

But I invest in stocks for the income, so i do not look at price as my return.
Sure my total value of stocks (aside from the TFSA) are still down from August 07. They are still worth more than what I originally paid for them. 

More importantly, even with a few dividend cuts (GE, BAC, C) my income from the stocks has always been higher than the year previous.
As far as i am concerned I have never lost money.

I am just at the point of thinking autopilot the whole thing via indexing or managed mutual funds.

Or perhaps a combination of everything.


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## Jon202 (Apr 14, 2009)

Bean, just to warn you, you will not be able to convince leslie. He/She is trying to carry over drama and baggage from the some other forums regarding this and other topics. He/She will cite a shaw members website without claiming authorship. Better off just to drop it.


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## leslie (May 25, 2009)

We are NOT talking about two different metrics. We are talking only about the metric Bean438 calls "div yield on cost". The one that generates the huge percentages that allow him to claim: _"I enjoy a market beating return."_ The delusion produced by this metric has convinced him to put his investment on "autopilot" and ignore his total returns, and most importantly, try to convince other people to do the same.

The claim to beat the market requires you to compare returns. Yet neither of you can say "what the metric measures". Since it is implicit that its results are being compared to the 'normal' dividend yield (that measures the future year's income) you must be able to defend your claim that his investment will be worth 10.2% more, a year from now assuming no change in stock price, than it is worth today. Of course it won't.... Because the metric does NOT measure the expected return. It doesn't measure anything. It is just two numbers divided by themselves.

Neither of you could explain away the challenge I have presented three times above. If your metric has validity how can two people in exactly the same economic position (past, present and future) have to claim different yields? You cannot rise to the challenge, because your position is not defensible.

The issue of 'simple interest' versus 'compound interest' has nothing to do with this issue.

The definition Mockingbird gave for 'investment yield' metric (ROI Return on Investment) is NOT the way the 'yield on cost' metric is calculated. So I must digress and show how financial yields on initial investment (IRR Internal Rate of Return or CAGR Compound Annual Growth Rate) are calculated. 

Below I show the results over two years of an investment. Beside it I show the as-if results that prove the IRR calculated on the initial cost was correct. In both cases you see that the calculation of the %return / $return are calculated based on the investment's value AT THE BEGINNING OF EACH PERIOD BEING MEASURED. 

..................................................*Actual performance*........*IRR=9%*
Purchase/investment..............................$100......................$100
annual return Yr1...................................8%..........................9%
equals income of ..........................8%*$100=$8.00........9%*$100=$9.00
--------------------------------------------------------------------------
Value at beginning of Yr2.......................$108..........................$109
annual return Yr2...................................10%...........................9%
equals income ...............................10%*$108=$10.80......9%*$109=$9.80
--------------------------------------------------------------------------
Value at beginning of Yr3......................$118.80........................$118.80

So yes the IRR is "based" on the initial investment but it is NEVER calculated on the initial investment/cost. The divisor is never the cost$. It is ALWAYS calculated on the value at the beginning of the period being measured.


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## bean438 (Jul 18, 2009)

Leslie, I enjoy a 9.2% return on 4700 of invested capital. If the stock stays the same price forever I will continue to get my 9.2%, provided there are no dividend cuts.. 
If the stock stays the same and the dividend goes up then my return will be even higher.
The capital appreciation is a bonus. I agree with your math, but if i were to sell and then repurchase, yes the dividend income will be the same, BUT the return is based on 9100 of invested capital, based on todays prices.
Seriously, why would I sell? I bought my 2 stocks at almost the bottom in March, and I am getting 9.2 on 4700 of invested capital, which is now worth 9100 dollars.
If this isnt a case of buy and hold, I do not know what is.
Sure if things change, dividend cuts, bad management, rising payout ratios, etc, I could possibly sell.
If I can get more than 460 in dividends on 9100 of capital then I could consider selling.

I purchase stocks for the same reason people buy bonds and GIC's.....income.

Bonds fluctuate too but people are not too concerned as they usually hold them to maturity, and get their original capital back with no growth.

Some peopl consider return as the difference in what they paid vs what they sell for.
I do not. My goal is to buy quality companies with growing dividends and hopefully hold forever.
You should read "the single best investment" by Lowell Miller.
It is an excellent book on dividend investing


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## FinancialJungle (Apr 22, 2009)

bean438 said:


> Personally I have an existing TFSA with 2 stocks, BMO and PWF, purchased luckily in march. Yield on cost is [9.2%] along with a handsome capital gain. *No reason to change that as I enjoy a market beating return on dividends alone* , and hopefully a capital gain that moves in tandem long term with the dividend increases. I also enjoy a huge margin of safety.


Leslie, let me give it a crack.

Bean438, it's irrational to hold a stock just because your yield-on-cost is "market beating" as you put it. Your unrealized capital gain up to this point is in the past. Your decision to redeploy should base on the best opportunity available *today*. You will not lose your "market beating" advantage by selling your dividend stocks now. 

Let's use a couple of ficticious stocks as examples.

You bought stock AAA at $100 with an 8% yield. In year 2, the stock appreciates to $200. Yield-on-cost is remains at 8% but market yield drops to 4%. 

Suppose stock BBB (with similar fundamentals) is currently trading at $100 yielding 8%. 

Is it rational to hold stock AAA because yield-on-cost is 8%? Or, is it better to sell AAA and buy BBB with twice the dividends? These are your opportunities *today*. It's irrelevant what your yield-on-cost is.


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## bean438 (Jul 18, 2009)

I am not holding the stock only because of the high yield. i enjoy a HUGE margin of saftey. Bought the stock below book value, I believe the dividend is sound, and will in fact start to increase again. Along with the dividend increase comes capital growth.
BMo was trading well above it's average yield.

Bottom line is i enjoy a 9.2% return on my initial 4700 dollars of capital.

The reason I purchased the stock in the first place has not changed so there is no need to sell it .
AAA or BBB having a higher yield is not relevant. I do not invest by yield alone.

The point I was trying to make was my investment yield is high, I so far have an 80+% capital gain, and i am confident BMO will be here in 20 years, and the dividend will grow, taking the stock along with it.

Yes there are always opportunities out there, and I am always on the look out. But I am quite happy with my TFSA so far.


Read "the single best investment" by Lowell Miller


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## bean438 (Jul 18, 2009)

Lets leave the poor horse alone now.

No one has said anything yet about index funds and distributions. Regular funds dont seem to make distributions that much considering they hold dividend paying stocks.
I suspect the MER has something to do with that.
What happens with the td index distributions? Do they sit as cash, or do they get dripped?

Can an index fund be used in a smith manoevre and still keep CA happy?


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## leslie (May 25, 2009)

I agree with Financial Jungle's post. He gives a perfect (and VERY common) example of the wrong decision-making that results from using this metric. 

What I object to is the use of the metric (future yr's dividend divided by purchase price). All the discussion on whether a particular stock should be sold or held is simply changing the subject. Arguing about what someone's investment objective is/should-be is simply changing the subject. Nobody is 'bashing' anyone's objectives.

The metric is not "the bottom-line" for anyone's investing objective. Bean438 refuses to optimise his own stated investment objective (_"I purchase stocks for income_") because he refuses to calculate what income his money (today) could buy.

And the metric does not measure 'growth of the income' either. To accomplish that you would divide the current distribution by the original distribution (less 1). And you would never call it 'yield' or compare its resulting percent to the 'normal' yield percent.

Using the metric to justify buy-and-hold ("_If this isn't a case of buy and hold, I do not know what is_") is another error in logic resulting from this insidious metric. A dollar is a dollar is a dollar. It makes no difference if a dividend received comes from a stock you have held 10 years of if you just purchased a replacement. The dollar dividend does not become 'more valuable' just because you have held the stock longer (bought at lower price). There is no 'moral' benefit from refusing to exchange holdings. The past is irrelevant.

The metric (div yield on cost) measures nothing, is meaningless, promotes wrong decisions, and is delusional.


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## Mockingbird (Apr 29, 2009)

FinancialJungle said:


> Leslie, let me give it a crack.
> 
> Bean438, it's irrational to hold a stock just because your yield-on-cost is "market beating" as you put it. Your unrealized capital gain up to this point is in the past. Your decision to redeploy should base on the best opportunity available *today*. You will not lose your "market beating" advantage by selling your dividend stocks now.
> 
> ...


Financial Jungle, I agree with everything you said. But I do not believe that is the issue here. Bean438 sees the dividend he receives in terms of GIC or other fixed rate term instruments. He did qualify himself as saying “yield on cost” (cost yield).



> Investopedia explains Yield
> This seemingly simple term, without a qualifier, can be rather confusing to investors.
> 
> For example, there are two stock dividend yields. If you buy a stock for $30 (cost basis) and its current price and annual dividend is $33 and $1, respectively, the "cost yield" will be 3.3% ($1/$30) and the "current yield" will be 3% ($1/$33).


Of course, in an ideal investing world, the “decision to redeploy should base on the best opportunity available today”, but tell that to many smartest hedge/institutional fund managers who even could not keep up with the broader indices. His investing timing was probably better than the majority anywhere (regardless of luck or skill). Metrics are good if you try to compare apples to apples, but I do not believe he is trying to prove anything aside from sharing his great investment-timing story. He stated that he just bought those stocks in this March, so I am sure most in this forum know what he is trying to convey. Hope Bean438 does re-evaluate his portfolio regularly though. Then he will recognize the true yields on his investments.

Being rational or irrational is another matter all together in this subjective investing world. If I remember correctly, many criticized those who held 3% yield GICs few years back.


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## Mockingbird (Apr 29, 2009)

bean438 said:


> I have a few questions.
> 
> 1. Dividends... obviously indexes have dividend paying stocks in them. How does that work? Are dividends simply reinvested in new units of the fund as they are received?
> 
> 2. Witholding taxes. In a TFSA I know canadian dividends are fine. Us dividends will be witheld at 30%, and "foreign" witheld at whatever rate the hosting country determines.


Since nobody answered your questions..

1. Not all in index funds distribute dividends since some might not contain dividend-distributing stocks (especially small cap growth oriented stocks). You need to check though. For the sophisticated individuals who hold short/ultra short index funds, the cash could be actually debited out of their accounts. The dividend amount should be deposited into your account unless you sign up for some sort of Dividend Purchase Plan (DPP) with your broker. Then the amount will be used to automatically purchase new shares of underlying stock (usually minimum of one whole share). Not all instruments will be qualified as such, so you need to check with your broker.

2 US Withholding Tax on dividend is 15%. Unfortunately, you cannot claim the foreign tax credit nor recover from them.


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