Cash: good stuff to have around

The market is up, way up. For me that is a sign to take a little off the table. This feels good, having cash is always reassuring but take care not to cash out too much. Diversification is as important here as elsewhere. Cash is but one investment in a well diversified portfolio.

Today, my money market fund (TDB8150) is paying 3.3%. Sounds good but keep in mind that inflation is running at 1.6%. This is good, really good, but it still affects buying power. The return on your money market funds will feel more like 1.7% when it comes time to spend it. Ouch.

Let's compare cash to the TSX. The last decade has been a bit of a dog. The Canadian market has not performed nearly was well as the U.S. one. Still, it managed to return approximately 3.0% annually for the ten years in question.

This 3% annual growth in the index value does not include dividends. Include dividends and the total return—which combines both price appreciation and dividend income—brings the total return closer to 6.0% or a little more.

Converting some of your equity winnings into cash has the following rewards:

• A major expense such as a roof does not pose a threat to your financial well-being. You have the cash to cover it. You will not be forced to sell equities in a falling market.
  
• Drawing from your cash reserves rather than relying on dividends, means you spend the interest paid on your cash as it accumulates rather than allowing it to lose value with the passing of time.
• Having a nice cash cushion enables you to pick up the stock market bargains appearing during a bear market. Buy low is only six letter until you have the cash to fulfill  your "buy low" goal. Warren Buffet likes to hold a fair amount of cash for just this reason: to be able to buy low when the opportunity arises.
• A portfolio is more diversified when a meaningful amount is kept in cash.
  

What kind of investor are you?

What kind of investor are you? This is a very important question and it important for you to have an answer. Generally, investors fall into two main categories: buy-and-hold or short-term trader. Each category has its own characteristics.

What am I? I'm in a sub-category of the buy-and-hold group. I buy-and-hold but, for the most part, only dividend paying stocks. I firmly believe the value of my investments will appreciate with time but it is the dividend that I need in retirement. A rule of thumb says stocks will appreciate two thirds of the times and loose value one third of the time. I ride out market corrections and even bear markets confident that the rule of thumb will hold. Buying on the dips is nice but I don't worry about hitting the ultimate low. Market timing is out.

Short-term traders are different. They buy and immediately begin thinking of selling. They want capital gains. Dividend paying stocks and non-dividend paying stock are treated almost identically. Market timing may play a big role with short-term traders who try to predict the best time to enter or exit stock positions.

Short-term traders are far more likely to use technical analysis with its emphasis on short-term price movements. A belief that historical price movements give an investor a window into today's action is essential. Stuff like Moving Average Convergence Divergence (MACD) is used to identify trends and reveal upcoming reversals.

As a buy-and-hold investor with a focus on dividends, I enjoy the following benefits:

• Dividends: Dividend-paying stocks like Enbridge (ENB) or CIBC deliver a solid income stream which, in my case, can be drawn upon in retirement. How solid is the ENB dividend? ENB has paid dividends for over 69 years without missing a payment. Over the past 29 years, the ENB dividend has grown at an average compound annual growth rate of 10%. As a retiree, this growth is greatly appreciated.

• Simplicity: The buy-and-hold strategy minimizes the need for constant monitoring of market fluctuations and eliminates the stress of being forced to make frequent trading decisions. Short-term volatility is not a concern.

• Lower Trading Fees: Buy-and-hold investors trade less frequently. Far fewer trades means smaller trading fees.

• Tax Efficiency: Buy-and-hold investors face capital gains tax only when they sell. Holding stocks for the long term amounts to a tax deferral until the sale. Although the tax on dividends must be paid annually, dividends are often taxed at favourable rate compared to regular income.

A long term investor is drawn to companies with strong fundamentals and a long history of profitability. When the market dives, a portfolio packed with quality stocks continues pumping out the dividends. A retiree can continue to pay the bills despite the reduced  portfolio value.

Utilities worth considering

If you want to read the conclusion and skip all the bumph, scroll to the bottom of the post to see my updated goals for the utilities holdings in my very diversified portfolio.

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I have owned Emera since a close friend told me it was a core holding of his portfolio. He was also a big believer in Fortis, another utility. Following his trusted advice, I have owned both for years. But now I have begun to wonder are there better utilities for the retired investor.

Utilities are often called defensive stocks, but they are not immune to market volatility. Utility stocks can still experience declines in value in bear markets. If interest rates rise, investor sentiment in dividend-paying stocks may wane and the stock price may fall.

Speak of volatility and Algonquin Power and Utilites immediately comes to mind. Algonquin, once a stock market darling, is now on the outs and with good reason. Its stock is down from its highs by more than half and its dividend has taken one serious cut and another dividend reduction may well be in the cards. Not a good stock for a retiree's portfolio.

I have to confess, I bought some AQN. I didn't buy it at its peak but it did cost me considerably more than is value today and today it is flirting with becoming a six dollar stock. The dividend, 36 cents (Cdn) annually, pays me to keep it in my portfolio but the future does not look all that promising. It is certainly not a buy today.

Another stock that did not make the cut was Northland Power. It's not for me. A 311.21% payout ratio is too high, as is its Price/Earnings ration at 86.5%. Numbers like this make me very uncomfortable. I don't need the worry when there are so many other, and possibly better, choices in the utilities sector. But, I must admit that many very respected analysts recommend Northland. Its dividend is 5.54% today and its price to book is reasonable and many are very positive about its future direction.

Another stock I own is AltaGas but unlike Algonquin Power it has treated me very well. It is up almost 300% since I bought it many years ago. So, why am I not recommding ALA? Because I am looking to sell. The yield had dropped to 3.464% because to the nice run up in price. When the price dips and the yield climbs above 4% I may buy back in but not now.

So, what utilities did make the cut? Well, Capital Power looks good. With a payout ratio of less than 50%, the dividend looks solid. The Sharpe ratio for CPX indicates that from a risk-adjusted perspective CPX is better than even Emera. CPX is on my list of stocks to buy in bear market.

• Dividend: 5.19% today
• Payout ratio: 49.19%.
• Price/book ratio: 1.7X
• Price/earnings ratio: 9.9X
• Quick ratio: 0.7X

In comparison, Emera has a payout ratio of 109.50%. The fact that Emera has racked up something approaching two decades of consecutive dividend growth, keeps Emera in my portfolio but I am not adding to my position.

• Dividend: 5.67% today
• Payout ratio: 109.50%.
• Price/book ratio: 1.3X
• Price/earnings ratio: 19.2X
• Quick ratio: 0.6X

Fortis looks good from almost any angle. The payout ratio is a little high but not a worry. Fortis has paid an annual dividend for the past 49 years. Impressive. I will continue holding Fortis. If the dividend was higher I might even add to my holdings.

• Dividend: 4.15% today
• Payout ratio: 73.16%.
• Price/book ratio: 1.4X
• Price/earnings ratio: 18.6X
• Quick ratio: 0.6X

Canadian Utilities With a solid dividend run of 51 years, CU looks like another contender. Still a payout ratio of 105.40% it a little high and with a price/earnings ratio of 17.9X, I will be waiting for a correction.

• Dividend: 5.10% today
• Payout ratio: 105.40%.
• Price/book ratio: 1.8X
• Price/earnings ratio: 17.9X
• Quick ratio: 1.2X

Brookfield Renewable Partners L is my second last choice. But BEP.UN comes with a number of caveats. The payout ratio was difficult to find. Why? Because the company is not profitable making it impossible to calculate a payout ratio. Like wise the P/B and P/E are not to be found.

How did an unprofitable company make the cut? The Brookfield name. Brookfield is a name I trust. But trust only goes so far. In the past, I have lost money  following the confident predictions of analysts. I wouldn't invest more than one and a half percent in BEP.UN. I'm conservative.

How is it possible for a money-losing company to pay a dividend and a generous one at that: 5.32%? I believe Brookfield Asset Management, the parent company, manages BEP.UN's finances to ensure liquidity and operational efficiency. This management approach can involve prioritizing cash distributions over immediate profitability. Does it? I don't know, but it looks possible.

Some analysts believe Brookfield Infrastructure Partners LP, with a dividend of 4.71%, can complement BEP.UN in a portfolio. Be aware utilities are not the main focus of BIP.UN. Still, I am going to put both Brookfield companies in my portfolio.

And now to reveal my updated goals for the utilities holdings in my very diversified portfolio:

• (1.2% in AQN)
• 1.5% in BEP.UN 
• 1.5% in BIP.UN
• 3.0% in CPX
• 3.0% in CU
• 3.0% in EMA
• 3.0% in FTS

The above represents 15% of a $165,000 retirement portfolio. The above does not include AQN which is on the chopping block.

A $25,000 investment in utilities divided equally between CPX, CU, EMA, FTS and the Brookfield pair would deliver an annual income of $1,256.25 or 5.025%. (The AQN is included here but only because I am stuck with it. Maybe I should take the loss.)

Minimizing Risk -- setting limits

I'm updating my portfolio. I'm reconsidering what I own and how much. And how much is too much when it comes to stock ownership? This a core question that must be asked by all investors. Ignore it at your peril.

In an income-weighted retirement portfolio the rule of thumb is to put no more than 5% to 10% of the total portfolio value in any one stock. Following this rule lessens risk and encourages diversification.

Risk Management: As an investment in any one stock grows, one's exposure to company-specific risks grows. Think of Nortel. If you don't understand, Google Nortel or click the link.

Diversification: A well-diversified portfolio holds a variety of stocks spread over a good mix of sectors and asset classes. For instance, if it has been determined that the investment goal is to have 12% of the portfolio value invested in the telecom sector, this investment would encompass a number of telecoms and not just one. 

An equal weighting of 3% each of BCE, Cogeco, Quebecor and Telus would result in a 12% total investment in telecoms. Of course, equal weighting is not demanded. Personally, I would underweight BCE and overweight Telus and favour Quebecor slightly over Cogeco with the remaining funds.

Income Generation: Always be aware of the income potential of any investment. But a warning, do not let the need for income overly influence your investment decisions. A very large dividend can be a warning and not a carrot. Don't take the bait. 

BCE is yielding 8.5% today. That is a warning. I suggest underweighting BCE in your portfolio and overweighting your investment in better positioned telecoms is the right approach. I have done much better with Cogeco and Quebecor than I have with BCE. The jury is still out when it comes to Telus.

Portfolio Adjustments: As a retiree grows older, the usual recommendation is to reduce the exposure to equities and increase the fixed-income investments. This can be tougher than it sounds. Move funds from equities into bond ETFs and money can still be lost. Put the funds in GICs and if inflation outpaces the interest paid, one suffers a loss in buying power. Losing, like winning, is simply part of life. Just try to win more than you lose.

I swim against the tide here. I like to have massive dividend income generated by trusted companies. When expenses are as expected, there is money left to reinvest in the market. When unexpected costs arise, the flow of cash is used to meet or at least reduce the unexpected cost. So far, this approach has worked well for me. I usually have no more than 2% of my funds in cash but I am flexible.

Conclusion: I cannot state this too strongly. Never allocate more than 10% to any one stock. This is the one rule that I have that is carved in stone. Some analysts will advise putting more into a stock and they will call this an aggressive income strategy. Don't do it! Think Nortel.

By the way, the art shows a small piece of my actual retirement portfolio spreadsheet.

Using Ai to Evaluate Investments

Lately, I've been experimenting with an Ai program, Perplexity. It is proving amazing. Yesterday I asked Perplexity to play Canuckle, a word guessing game. It discovered the word in four guesses.

Today, I thought of asking Perplexity to compare Atco and Canadian Utilities and I wondered if there was any reason to hold each in one's portfolio as ATCO is the principal owner of Canadian Utilities Limited with a 52.7% stake. I loved its answer. 

It said, "When considering whether to invest in Atco Ltd. (ACO.X) or Canadian Utilities (CU), or both, it's important to analyze several factors such as dividend yields, growth potential, and overall business strategies. The following is also from its answer.

Dividend Comparison

• ATCO Ltd.:

  • Dividend yield is approximately 4.062%.

  • Recent quarterly dividend is $0.4898 Can. per share, reflecting a commitment to increasing dividends over time.

• Canadian Utilities:

  • Higher dividend yield at about 4.983%.

  • Quarterly dividend is $0.453 Can. per share, with a remarkable track record of increasing dividends for 52 consecutive years. It must be acknowledged that CU also has a history of increasing dividends over time.
    

Financial Performance and Growth

• ATCO Ltd.:

  • Reported adjusted earnings of CA$655 million.

  • Focuses on essential services with a diversified portfolio, including energy infrastructure and logistics, which positions it well for future growth.

• Canadian Utilities:

  • Adjusted earnings of CA$596 million, with a strong emphasis on regulated utility operations.

  • Plans to invest CA$4.6 to CA$5 billion in regulated utilities from 2024 to 2026, aiming for sustained earnings growth linked to infrastructure development.
    

Payout Ratio

• ATCO Ltd.:

  • Payout ratio: 56.5%. (Morningstar)

• Canadian Utilities:

  • Payout ratio: 91.1%, (Morningstar)

Strategic Focus

• ATCO Ltd.:

  • Diversified across energy, logistics, and structures.

  • Emphasizes sustainability and innovation in energy solutions.

• Canadian Utilities:

  • Strong focus on regulated utility businesses and energy transition initiatives.

  • Aims for long-term resilience through strategic investments in infrastructure and technology.

Credit Ratings Overview

• ATCO Ltd. has received a Baa2 rating from Moody's, which is considered to be the fourth highest level on their scale. This rating suggests that ATCO has adequate capacity to meet its financial commitments, but it is subject to some risk during adverse economic conditions.
• In contrast, Canadian Utilities Limited holds a higher rating of A3 from Moody's. This rating implies a stronger credit profile, indicating that Canadian Utilities has a solid capacity to meet its financial obligations and is less susceptible to economic fluctuations compared to ATCO
• Both ATCO Ltd. and Canadian Utilities Limited got similar ratings from S&P (A- with a stable outlook).

Conclusion: Which is the Better Investment?

As can be seen from the information supplied by Perplexity, ultimately the decision must align with one's investment strategy, risk tolerance, and income needs. My investment strategy revolves around dividends. I am retired, I need dividends to live, to make ends meet. 

My risk tolerance is high enough to allow me to own equities rather than GICs and the like. I can accept volatility. That said, stocks can go down but after that they must recover. I do not want a Nortel in my future -- a permanent loss. As this cannot be completely ruled out, I have set limits on how much I will risk by investing in any one stock. I never want to invest as much as 10% of my portfolio in one stock. Five or six percent is a much better ceiling and very few stocks should approach this maximum investment.

As Canadian Utilities yields almost a full percentage more than Atco, I find myself leaning towards making only one investment -- Canadian Utilities. I need the income. Moody's may see both as investment grade but it rates CU a little higher. That is another plus for CU over ACO-X.

To put all the above in perspective, those solid standbys in the utilities sector, Emera and Fortis, do not have ratings as high as either Canadian Utilities or Atco plus Fortis does not meet the four percent yield rule. 

I'm thinking of investing three percent of my retirement money in CU and a further one percent in Atco. Fortis will get the nod for two percent based on its narrow economic moat determined by Morningstar. Emera gets the nod for a three and a half percent investment as it yields the most and can be found in almost all published retirement portfolios.

There is one more utility that I would like to see in my retirement portfolio: AltaGas. Why? I have owned it for years and I have enjoyed a very nice capital gain along with a reliable dividend with sustainable increases. AltaGas gets one and a half percent of my portfolio.

My total investment in the utilities sector is eleven percent with no stock accounting for more three percent of my portfolio. Good income is assured and there is no possibility of a Nortel-like disaster. I can sleep at night. If Hydro One were to drop in value, thus raising its percentage yield, I would consider adding one or two percent of Hydro One to my portfolio but today the yield is simply too low.

Should I be looking at low beta stocks?

Beta is a measure of a stock's volatility in relation to an index like the S&P 500 or the S&P/TSX Composite Index. A beta of:

• 1.0 indicates that the stock moves in tandem with the index both up and down.
  

• Less than 1.0 indicates the stock is less volatile than the index. It tends to suffer smaller price fluctuations, suffering lower losses during market downturns and benefiting from smaller gains during bull market periods.
  

• Greater than 1.0 indicates higher volatility. Price moves are more extreme than those of most stocks. Gains can be exhilarating but when the inevitable losses occur, taking the hit can be tough.

Can retirees benefit from owning low beta stocks? I believe they can. Low beta stocks tend to have smaller losses during market corrections or bear markets. On the other hand, and this is surprising, studies have shown that low beta stocks can outperform the market over the long term despite their lower volatility. 

This casts doubt on the widely held belief that higher risk is necessary to enjoy higher returns. A back-test of a low-volatility portfolio, rebalanced annually with a maximum of 15 stocks, found that the low-volatility investment strategy followed from February 2007 to February 2018 produced an annualized total return of 12.7%. The S&P/TSX Composite total return index advanced only 4.9% over the same period. 

Clearly, these low beta stocks outperformed their high beta counterparts even though they must have endured both bull and bear markets together. A lot happens in the market over a course of 11 years. Some of the low beta stocks included in the study are the same low beta stocks often found in the portfolios of retirees.

• BCE
• Brookfield Renewable Partners
• Canadian National Railway
  
• Canadian Tire Corporation
  
• Emera
• Fortis
• Great-West Lifeco
  
• Hydro
• Loblaw Companies
  
• Pembina Pipeline

It appears low beta stocks, contrary to accepted dogma, may very well outperform high beta stocks over time and through varying market conditions. And many low beta stocks are issued by long established companies paying very nice dividends. The result is steady income thanks to the dividends plus out-performance and managed risk -- all qualities that are much appreciated in retirement, or anytime if one stops to think about it.

I knew there was a reason I liked Emera. (Just moments after posting this, I read the following on the TSX Internet site: "Emera Announces Increase in Common Dividend, Marking 18 Consecutive Years of Growth."

I'm wrong but I'm comfortable with my errors

There are a number of common myths surrounding investing. Most serious investors have seen and heard these myths and most of us ignore one of more of them at times. These may be myths but they do seem to fly in the face of common sense.

Just the other day I said I was taking money off the table and increasing my cash holdings. The market is booming and I am reducing my exposure to the market. Why am I doing this? I fear a correction or worse -- a bear market. This is called moving to the sidelines in anticipation of a market downturn and it is a myth-driven action according to the National Bank and others.

According to the National Bank: If you're anticipating a stock market pullback, you're probably right, as declines of at least 5% occur virtually every year; corrections of 10% occur in six out of ten years and corrections of around 15% occur in four years out of ten.

Nevertheless, history shows that investors willing to stay invested through these fluctuations are well advised, as even the average return in years marked by a correction of 10% or more is positive.

Investors whose investment horizon allows for patience are probably better off accepting rather than fearing the inevitable market pullbacks.

The above is a lot like the much discredited market timing belief. Timing your stock purchases to  the market highs and lows is much harder than it sounds and if you could do it you would not be rewarded with a greatly improved income. 

In the example given by the National Bank, invest when the market is at its low point for the year each year for more than three decades and you might see an annual return of 9.1%. If you had ignored market timing and simply invested at the start of each month, you would have had an annual return of 8.6%. But, do you really think you could nail the low for each year steadily for some three decades or more? I assure you; you can't. You would be lucky to see an annual return of 8.6%.

At least taking some money off the table when a downturn is anticipated protects some of one's investment -- or does it? Sadly, it is difficult to time the rebounds. If you stay in, you benefit fully from the rebounds. If you are out of the market, you may miss some or all of the rebound. Miss the rebound and you may finish out of the money.

Investing in the market is not gambling. With gambling, in the long run the house always wins. With investing, in the long run the investor wins. Look at any graph of the TSX. Over a long time period, the market always goes up. Buy, hold and win.

And while biding your time, patiently holding those stocks that have briefly tanked, cash you dividends and smile. According to the National Bank, dividends account for 70% of the total stock market gains since 1980.

Hold the right stocks and the dividend will be awfully secure. The Bank of Montreal has maintained its dividend without cutting or reducing it for over 190 years. The Bank of Montreal is not alone. Enbridge has paid its dividend without cutting or reducing it for over 69 years and Fortis Inc. has not disappointed for over 49 years and the telecom Telus has racked up an impressive 20 year winning streak.

Buy, hold and enjoy the dividends.