All Canadian investors should understand Canada’s stock market history.
As I’ve shifted to index investing over the past eight years, my questions about the Canadian market only grew:
- What are the two primary indices in Canada?
- What are the historical returns of the Canadian stock indices?
- How have dividends contributed to the total index return?
- What has been the dividend growth rate?
- How do taxes on dividend income impact returns?
I could not find answers online. In response, I crunched data in excel from the world’s first index Exchange Traded Fund, XIU.
- Annualized return without reinvested dividends: 5.0%
- Annualized return with reinvested dividends: 7.5%
- Average annual dividend yield: 2.6%
- Dividend growth rate: 7.9%
Table of Contents
Total Return vs Price Return
You do not see reinvested dividends when you Google a specific index ETF or stock. The chart reflects the “price return” only.
A more accurate measure of investor outcome is the total return, including reinvested dividends. For stocks that don’t pay dividends, like Google, the price return equals the total return.
S&P TSX Index Dividends Since 1999: With and Without Dividends
To see the power of reinvested dividends, consider $10,000 invested into the S&P TSX 60 Index in September 1999 to March 2023:
- Without dividends reinvested: $31,500
- With dividends reinvested: $54,700
The Two Main Canadian Indices
An index is a collection of stocks (or bonds). There are two primary stock indices in Canada.
First, there is the S&P TSX Composite index, which consists of 236 stocks at the time of writing. Second is the S&P/TSX 60 index, consisting of the 60 largest Canadian stocks.
As you can see, the total return (including reinvested dividends) is very similar for both indices.
Stocks on both indices trade on the Toronto Stock Exchange (TSX). The Toronto stock exchange has 1,640 companies at the time of writing (March 2023).
The S&P/TSX Composite Index
The S&P/TSX contains 236 of the 1,640 stocks listed on the TSX. The index excludes tiny stocks. For more on the criteria for including stocks, you can read the index methodology from S&P Global.
Since stock size is Pareto distributed, a few stocks comprise most of the stock market wealth. For example, the 236 stocks on the S&P/TSX Composite index represent over 95% of the value of the Canadian stock market.
Going back to 1979, the S&P/TSX composite index has had a total return of 8.7%, according to Taxtips.ca. Please note I don’t have 100% confidence in this source.
Currently, the total dividend yield is 4.2%, as measured by the index ETF VCN as of Jan 2023.
The S&P/TSX 60 Index
The S&P/TSX 60 index holds Canada’s largest 60 stocks from the S&P/TSX Composite Index. See more about the S&P/TSX 60 index methodology.
You may say, “Only 60 stocks! The Canadian market has 1,640 stocks. That’s only 3.6% of the stocks. How can this index be a good proxy for the Canadian market as a whole?!”
You are right. But here is the thing. The largest 60 companies are worth $2.5 Billion at the time of writing. And all 1,640 stocks that trade on the TSX are worth $3.4 Billion.
Therefore, only 60 stocks make up 74% of the total wealth of the Canadian market. A Pareto distribution, again.
I could not find data going on the S&P/TSX Composite index. The S&P/TSX 60 data is the best I can do to measure the entire Canadian stock market.
As of March 2023, the S&P/TSX 60 dividend yield was 3.5%.
S&P/TSX 60 Sector Breakdown
On a related note, here is the sector breakdown of the S&P/TSX 60 index.
Note the high concentration in financials and energy. I diversify my stocks internationally to improve sector diversification.
I love diversification … it reduces risk without reducing expected returns.
Canadian Stock Market Dividend Growth Rate
Dividends of the top 60 companies have grown at 7.9% annually from 1999 to 2023.
Therefore, Canadian dividend growth has outpaced the US market’s 6.5% dividend growth rate, but perhaps that’s due to the growing use of share buybacks for US companies.
A second data source from RBC shows that dividends have grown at 6.5% since 2006. This makes sense, given the flattening of dividend growth between 2006 and 2013.
Here is something interesting: since 1999, dividend growth (9%) has exceeded price growth (5%). Dividend growth is indicative of underlying earnings growth.
Therefore, I assume that earnings growth has outpaced price growth. This means that market valuations have dropped, and dividend yields have increased.
Long-run stock returns = dividend yield + earnings growth. A dividend yield of 3.5%, and earnings growth of 7% equates to a 10.5% annualized return.
With this approach, the Canadian market is postured for higher expected future returns than in the last 20 years.
Taxes on Canadian Dividend Income
Taxes on dividend income starts to matter when tax-sheltered accounts like the RRSP, TFSA and FHSA are maxed. I discuss this more in my post TFSA Maxed: Now What.
Dividends from stocks in the index are almost all eligible dividends. As you can see, eligible dividends are taxed at favourable rates, especially those earning under $100k/yr.
Why are Canadian dividends more tax efficient?
By owning stock, you own a portion of the company. And the dividend represents a portion of that company’s earnings. This company already paid tax on its earnings before paying you a dividend.
Therefore, the dividends you receive have already been taxed. To prevent double taxation, you get the dividend tax credit. I discuss this in more detail in my Ultimate Guide on Taxes on Investment Income.
How Do Taxes on Dividend Income Impact Returns?
Dividends are taxed before they are reinvested, even if you have DRIP enabled on your index ETF.
To see the effect of taxes, consider a dividend yield of 3%, and a 25% tax rate on dividend income. Your effective dividend will only be (3%)*(.75) = 2.25%.
Therefore, a 25% dividend tax rate will erode your total returns by 0.75%. This has a noticeable effect when compounded over a long time horizon.
Dividends: They Don't Matter
As I’ve learned more about investing over the past eight years, the more I’ve realized that dividends don’t matter (apart from a behavioral impact).
Yes, targeting dividend stocks has provided higher returns, but it’s not because of the dividends. Instead, dividend stocks happen to be value stocks. And value stocks have higher returns.
I understand this might shatter some deeply held belief systems. That can be hard and uncomfortable. I cover this dividend misconception in more detail in this post.
Methodology For S&P/TSX 60 Dividend Growth
You may wonder, “Jake, how did you measure this?”
For dividends and total returns, I used the XIU distribution history direct from the BlackRock website. I excluded reinvested capital distributions.
The index fund XIU holds all 60 companies in the index. When the underlying companies pay dividends, they are collected by the fund and distributed to fund owners.
Since there is churn in the top 60 companies, sometimes a stock drops off the index. When this happens, the underlying fund must sell a stock and purchase a new (larger) stock.
Therefore, some distributions include capital gains from selling stock in the fund. I excluded capital gains distribution in my data, leaving behind the collective dividend growth of the companies in the fund.
Conclusion
The Canadian stock market can be proxied by world’s oldest index fund, XIU. This fund has tracked the S&P/TSX Composite index since September 1999.
During this time, the market has returned the following:
- Annualized return without reinvested dividends: 5.0%
- Annualized return with reinvested dividends: 7.5%
- Average annual dividend yield: 2.6%
- Dividend growth rate: 7.9%
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Jake out.
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