The case for dividend-paying stocks

Many investors know they need to achieve a certain return on their investments in order to reach their retirement savings goals. However, many are unsettled by extreme market volatility or the fear of losing money, and so they may be reluctant to invest in equities (i.e., stocks). Products such as guaranteed investment certificates (GICs) or savings accounts might be safer choices, but they likely won’t generate enough returns to grow your investments and outpace inflation. Investors who are wary of taking on the risk that equity investing entails may want to look at dividend-paying equities. They can offer attractive returns, lower risk and a steady flow of income.

What are dividends?

Dividends are distributions that certain companies pay out of the earnings they generate from their business operations. Dividends are often paid once per quarter but some companies may choose to pay at a different frequency, i.e., monthly or annually. Typically, dividends are paid by mature, profitable companies. Since these companies are no longer in a phase of rapid growth, they elect to return a portion of their earnings directly to shareholders instead of reinvesting all of it into their business.

The paying of dividends indicates that a company’s fundamentals are healthy and that management is optimistic about future prospects. While dividends aren’t guaranteed, companies generally commit to making those payments to protect their corporate reputation and maintain investor confidence. At times, companies may cut or eliminate dividends as a result of company-specific issues (e.g., competitive pressures have lowered a company’s revenue) or broader industry issues (e.g., a large decline in oil prices may lead energy companies to trim or stop dividend payments). On the other hand, when circumstances are strong and a company is thriving, it may start paying dividends or increase the amount of existing payments.

Benefits of receiving dividends

It’s comforting for many investors to receive dividend payments. Not only do they receive a regular income stream, but if they’re focused on creating longterm wealth, they can ‘wait out’ short-term declines in a stock, knowing that they can be patient while collecting dividends from the company. Also, while interest income from GICs, savings accounts or bonds is taxed at an investor’s highest marginal rate, eligible dividends from taxable Canadian corporations qualify for the dividend tax credit, which can reduce the amount of tax an investor pays on that income.

Ways to invest in dividend payers

Choosing which dividend-paying companies to invest in is just as challenging as selecting other types of equities. You still need to consider the fundamentals of the company, the strength and future prospects of the particular industry plus whether the company has a strong history of making (and ideally, increasing) dividends.

One convenient way to gain access to dividend payers is to invest in a mutual fund where professional investment managers take care of the analysis, decision making and oversight. Some mutual funds are either mostly or completely focused on dividend-paying companies, while others are income-oriented funds with a blend of dividend payers and bonds or other fixed-income securities. Also, some mutual funds (e.g., a Canadian equities fund) are not focused on dividend payers, but include dividend payers like banks and utilities companies. Your financial advisor can give direction on the best way for you to access the attractive world of dividend-paying companies.

Talk to your financial advisor to learn more about how dividend-paying stocks can help you reach your long-term investment goals.