Dividends are income distributions from a company to its shareholders. But how powerful is 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 as a way to diversify their portfolios. Although companies are not obligated to pay dividends to investors, most continue to do so.

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.

 

The long-term advantages

Many stocks make automatic Dividend Reinvestment Plans (DRIPs) available, through which investors can 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&P500 over the past 70 years, with a long-term average contribution from reinvested dividends of over 40% of its total return (RBC Capital Markets Quantitative Research).

Suppose you invest $100 initially, and an additional $75 per quarter, at an anticipated stock price appreciation of 7% and an anticipated 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 8,166.42 – and your total value would be $16,516.29!

 

Dividend tax advantages

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. Dividends from foreign corporations do not receive the same dividend tax credit, and are taxed at a higher rate than those of Canadian corporations.

For example, if you earn more than $132,000 in annual taxable income, and receive $1,000 in dividend income from a Canadian company, you keep approximately $735 after federal and provincial taxes – less the dividend tax credit. By comparison, $1,000 in interest income will net about $555 after taxes – the same for $1,000 in foreign dividend income, because it is not subject to the tax credit for Canadian corporations, and is taxed at a higher rate.

When considered in light of total returns and tax advantages, dividend-paying stocks may be an attractive option. If you think it’s time to talk about the power of dividends, please contact me today at 604 981 2306.