The Power of Dividends

Dividends are income distributions from a company to its shareholders. But how powerful are the power of dividends in your portfolio?

Income-focused investors often look to dividend-paying stocks – typically large-cap companies that are less volatile – as a source of stability and income and also as a way to diversify their portfolios.

Although companies are not obligated to pay dividends to investors, most large-cap companies continue to do so.

Some companies have paid yearly uninterrupted dividends for several decades. As an example, the Coca-Cola Company (KO) has paid a yearly dividend since 1920, 3M Company (MMM) since 1916 and Johnson & Johnson (JNJ) since 1944.

Some investors see dividend payments as a signal of the company’s confidence in its future earning power, particularly in tenuous markets. They can also help to mitigate stock market downturns and act as a cushion for your portfolio during these more volatile times.

THE LONG-TERM ADVANTAGES

Many stocks make Dividend Reinvestment Plans (DRIPs) available, through which investors can automatically reinvest their dividends for future growth (and more dividends) instead of spending them.

These reinvested dividends can compound into significant returns over the long term.

In the United States, dividends have represented a significant portion of total returns for the S&P/TSX Composite Total Return Index, representing over 30% of the average annual total return (RBC Global Asset Management, September 2015).

Suppose you invest $100 initially, and then add an additional $75 per quarter, at an anticipated stock price appreciation of 7% and an anticipated low dividend yield of 2%. In 20 years, you would have invested a total of $6,025 and reinvested dividends of $2,324.88 for a total cost basis of $8,349.88. Your capital gain would be $8,166.42 – and your total value would be about $16,516.29!

Dividends can also act as a hedge to inflation as several of those dividend-paying companies have a track record of increasing their dividends over time. Some would consider their well diversified portfolio of dividend-paying stocks to be a reliable stream of income that will increase over time.

DIVIDEND TAX ADVANTAGES

When held outside registered accounts (such as RRSP or TFSA) dividends received from Canadian corporations are effectively taxed at a lower rate than interest income, due to the dividend tax
credit that is applied to the federal and provincial tax payable.

This tax credit is meant to recognize that the Canadian corporation paying the dividends has already paid tax on its earnings, which are now being distributed to its investors. It should be noted that dividends from foreign corporations (such as dividends from U.S. companies) do not receive the same dividend tax credit, and are taxed at a higher rate than those of Canadian corporations.

For investors who have corporate accounts or even personal taxable accounts, one possible tax strategy to minimize your overall taxes would be to maximize your allocation to Canadian dividend paying stocks inside your taxable accounts instead of your registered account to take full advantage of their tax benefit.

When considered in light of total returns, tax advantages and their ability to smooth down the impact of market downturns on a portfolio, dividend-paying stocks can be an attractive option for many, including those who are not necessarily looking from income from their portfolio. You should consult with your financial advisor about their benefits and see if they are the right fit for your portfolio and
investment strategy!

Mathieu's column, Your Financial Corner, will appear in each edition of Chamber Vision magazine, published by The Chamber of Commerce for Greater Moncton.

About the Author

Mathieu LeBlanc, CPA, CA, CIM

Associate Portfolio Manager, The Cormier Group of RBC Dominion Securities
Mathieu LeBlanc is a Chartered Professional Accountant and Associate Portfolio Manager with The Cormier Group of RBC Dominion Securities.