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There’s been a lot of news in the finance world lately. As the pandemic’s effect on the economy continues to ease, governments all over the world are gradually pulling back the economic measures that were put in place to prevent the economy from completely collapsing. A few months ago, both Canada and the US ended their pandemic unemployment benefits that financially supported people who were thrown out of work. Then, central banks announced that they would slow or eliminate their Quantitative Easing programs, essentially stopping the printing of money so that inflation can be brought under control. And now, one of the last pieces of pandemic-related financial policies is going the way of the COVID-infected dodo: restrictions on dividend increases and share buybacks.
When the pandemic first hit, many countries recognized that they would need to shut down their cities for at least some time, and they realized that if they didn’t financially support the same businesses they forced to close, there may not be much of an economy to come back to once the pandemic was over. So many countries implemented programs that would subsidize businesses expenses like rent or salary, in the hopes that it would keep them afloat long enough to participate in the eventual recovery.
But at the same time, those same governments didn’t really trust CEO’s for some reason. Well, I guess it’s not so much “some reason,” as much as those CEO’s showed their true colours during the 2008/2009 financial crisis when they gratefully accepted government bailout money, then turned around and enriched themselves by paying themselves dividends while letting their workers, whom the money was originally intended for, suffer needlessly. I mean, come on! If you can’t trust CEO’s to behave like decent human beings, who can you trust?
So to prevent that situation from happening again this time, the governments money came with strings attached. If a company participated in any of these stimulus programs, they were forbidden from raising dividends or performing share buybacks. Seems reasonable, right? If you’re going to take government money meant to keep you afloat, you’d better actually use it to stay afloat rather than buying your executives brand new yachts.
Cash is King
That being said, don’t think that dividends or share buybacks are somehow a bad thing. Under normal conditions, both dividends and share buybacks are a sign of a healthy, cash-rich company. A dividend is, after all, a sign that a company is making so much money that it can’t find enough opportunities to invest it towards growing their revenue, so instead they choose to distribute it among their shareholders. And share buybacks are similar, but return their value to their shareholders as a higher stock price (a.k.a capital gain) rather than cash.
So by forbidding both dividend increases and share buybacks, regulators not only prevented executives from raiding their company’s coffers and sailing off into the sunset, it also forced companies to keep a much higher-than-normal cash reserve on their balance sheet.
2008 taught policy makers the value of cash, especially for financial businesses like banks and insurance companies. As much as we all love hating on banks, when a whole bunch of people lose their jobs at once and start defaulting on their mortgages, if those banks don’t have enough liquid assets to counteract the wave of non-payments, they might be forced to go all Lehman Brothers on us, and that causes a contagion effect that makes the whole situation worse, so that was the situation everyone was trying to avoid with these rules.
Fortunately, it seems to have worked. Banks hoarded billions of dollars in anticipation of wave of defaults. But thanks to those government programs that gave cash directly to laid off workers, those wave of defaults never came. So without an immediate need for that money, and being banned from using their normal tools of returning that money to shareholders, financial companies began building up billions of dollars in their cash reserves the likes of which had never been seen before.
Which is why the following announcement was so juicy…
Canada’s banking regulator is immediately lifting pandemic-related restrictions that prevented banks and insurers from raising dividends and buying back shares, but is urging bank executives to act responsibly as they deliver long-awaited payouts to investors.Regulator will allow banks, insurers to raise dividends effective immediately, The Globe and Mail
Dividends, Glorious Dividends
I’m going to just come out and say it: I love, love, LOVE dividends.
A lot of FIRE bloggers rely solely on the 4% rule for their retirement budget, which to be fair will work the vast majority (95%) of the time, but it does have the major flaw of relying on constantly-increasing stock prices to make the math work. A bad couple of years at the beginning of retirement can decimate all your well-laid plans, and while it’s insanely unlikely, it can happen in about 5% of cases.
That’s why we are much more focused on the yield of our portfolio than other bloggers. Yield, which comes from a combination of interest and dividends, is far less likely to change day-to-day, unlike capital value which fluctuates up and down constantly based on the gyrations of the current news cycle.
But when you focus on your portfolio’s yield, you are automatically way safer than people who are depending on capital gains. Because your yield is mostly determined at the moment you purchase your shares, and that yield generally gets paid regardless of whether the stock’s value goes up or down, if you manage you get your living expenses within the yield of your portfolio, you no longer care about what the market does. It could go up, it could down, but you get paid your yield regardless. You become immune to market volatility.
That’s why I wrote our Yield Shield series. When you’re on your way to FIRE, it’s best to stick to a simple indexed portfolio like the one we recommend in our Investment Workshop, but once you actually retire and need the income, the game does change.
And for people in that situation like me, dividend increases are like music to our ears. Because when a company increases their dividends, they are sending out a signal that they have way too much money and don’t know what to do with it. That inevitably causes their stock price to rise as well.
We’re already starting to see this effect. Dividend increases were allowed as of last Thursday. A day later, one of Canada’s biggest insurance companies announced this:
Manulife Financial Corp. is the first Canadian insurer to announce a dividend hike after Canada’s banking regulator lifted pandemic-related restrictions.Manulife raises dividend by 18 per cent after regulator lifts pandemic restrictions, The Globe and Mail
That’s right. They not only increased their dividend, but they increased it by 18%. That is insane. Dividend investors hope to see their companies dividends beat inflation under normal circumstances, but as we all know, these are not normal circumstances. 18% is an insanely high dividend hike, and is really a reflection of how much cash these companies are sitting on more than anything else. The day after this got announced, I logged into our Passiv dashboard and was stunned to learn that our combined portfolios had gone up by $30,000 in 1 day from this change alone!
And remember, this is just one company. Most of the major banks in Canada won’t be announcing anything until late November, but they are all sitting on giant piles of cash just like Manulife. In fact, if all the Canadian banks simply restored their dividend payout ratios to their pre-pandemic levels, we would be looking at 20%+ increases across the board.
The next few months are going to be an extremely interesting time for index investors like us, that’s for sure…
We are getting out of this pandemic. It hasn’t been easy for, well, any of us, but it looks like we are slowly returning to something resembling normal. And whether it means eating out at restaurants again, or being able to BBQ with your friends, or in our case, seeing dividends start to pop back to the levels that we were used to pre-pandemic, I for one am so freaking glad to see a return to financial normalcy.
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