Some readers have emailed me about the dividend investing strategy, and specifically, why I follow it. Personally, I’m a believer of both index investing and dividend investing where both have their merits.
I use index investing for the accounts that are mostly hands off, like the RESP accounts for my children, and I even have a portion of my RRSP indexed. I use the dividend growth strategy through Canadian dividend stocks for my leveraged Smith Manoeuvre portfolio, U.S. dividend stocks in my RRSP, and recently have been purchasing REITs for our TFSAs. I have also started growing my non-registered account with Canadian dividend stocks.
So why dividend stocks? I’m an advocate for the dividend investing strategy for a number of reasons, these include:
1. Produces a Passive Income Stream for Life, and with Raises!
Passive income for life is a pretty optimistic statement but for good reason. There are a number of dividend companies that have a long history of paying dividends. For example, Coca-Cola (KO) has paid a dividend since 1893 – that’s right for 120 years! Not only have they paid a dividend for well over a century, they have increased their dividend for 50 years straight. They give raises to their investors just for holding onto their shares.
Relying on a company to keep paying their dividend may sound risky, but it’s simply a management priority of a company with consistent and predictable earnings. If a company like KO ran into financial difficulties, I’m willing to bet that they would do everything in their power to maintain their dividend.
2. Encourages Buying and Holding for the Long Term
The stock market has proven to increase in value over the long term, however, the problem is that most investors are their own worst enemies in selling during market lows and buying when the media tells us to buy during market tops. In order to benefit from the market over the long term, an investor must buy and hold. However, it can be tricky during the emotional swings of the market.
Dividend investors buy and hold (ideally forever) for the income (and raises) that the stock produces. If buying value (when the dividend stock valuation is attractive), dividend investors are basically paid to wait for their investment to turn around.
3. Helps Create a Market Bottom
When the broad markets decline or if interest rates are raised considerably, dividend stock prices may start to decline however dividend yields will increase. Providing that the business fundamentals are still strong and earnings/cash flow are enough to cover the dividend, the higher yield will likely attract income investors potentially creating a bottom, or even igniting a rally.
However, note that sometimes yields can get extremely high, which is a warning that the market may be pricing the stock in preparation for a dividend cut.
4. Dividends are Tax Efficient
Publicly traded Canadian dividend stocks are extremely tax efficient. So efficient, in fact, that an investor (in most provinces) can earn up to $45,000 in eligible dividends and pay $0 income tax (assuming no other income).
How is this possible? Canadian corporations pay corporate tax and pay dividends with after tax earnings. To prevent double taxation, investors get a dividend tax credit on dividends received within a non-registered account. If you’re interested, more detailed information on the dividend tax credit here.
5. Reduces Risk of Selling at Market Bottom for Capital
I follow the philosophy of nurturing the goose that lays the golden eggs. In this case, the eggs are the dividends received and the goose is the portfolio of dividend stocks. The goal for many dividend investors is to maintain the portfolio while spending dividends to cover monthly expenses.
It is a common strategy to sell portions of the portfolio to fund retirement. A pitfall in this strategy is if markets are down and cash is needed, the investor will end up selling at the bottom. This can cause damage, and may introduce sustainability issues, to the portfolio.
Back to you, are you a dividend investor? Why or why not?If you would like to read more articles like this, you can sign up for my free weekly money tips newsletter below (we will never spam you).