Are you taking advantage of dividends?

Most people invest with what seems to be a simple objective: to minimize risk while achieving decent after-tax returns. However, when you approach retirement, you may want to change your strategy to obtain income from your portfolio. For many investors, dividend-paying stocks and managed portfolios make good sense. Let's explore what dividends are and how you can make them work for you.

What are Dividends?

A dividend is a cash payment from a company's earnings, announced by a company's board of directors and distributed among shareholders. In other words, as a part owner of the company, an investor receives a share of the profits. A company can do one of two things with profits from its operations:

• reinvest them in the company in the hope of creating more earnings and thus further stock appreciation; or
• distribute a portion of the profits to shareholders in the form of dividends.

One advantage to including dividend-paying stocks in your portfolio is that dividend income receives preferential tax treatment over other types of income, such as interest earnings. For this reason, many investors who now have to live on their portfolio income may decide to increase the dividend earnings from their portfolio.

Dividends are straightforward

By choosing to pay dividends, management is conceding that it is more advantageous to distribute profits from operations to the shareholders than to put them back into the company. In other words, reinvesting profits to try to achieve further growth will not offer the shareholder as high a return as a distribution in the form of dividends.

Another reason for a company to pay dividends is that a steadily increasing dividend payout is viewed as a strong indication of a company's success. The wonderful thing about dividends is that they cannot be misrepresented. They are paid or not paid, increased or not increased.

As well, expected growth rates can be unreliable at times. A company can forecast impressive growth opportunities that will pay off in several years, but there are no guarantees that it will make the most of its reinvested earnings. When a company's robust plans for the future (which influence its share price today) fail to materialize, your portfolio will likely be negatively affected.

However, rest assured that no accountant can restate dividends and take back your dividend cheque. Moreover, dividends cannot be squandered by the company on business expansions that fail to thrive. The dividends you receive from your stocks are 100 per cent yours. You can use them to do whatever you want, such as pay down your mortgage, spend or re-invest elsewhere.

How can you invest to receive dividends?

Investors looking for exposure to the growth potential of the equity market, combined with the safety of the (moderately) fixed income provided by dividends, should consider adding stocks with high dividend yields to their portfolio. A portfolio with dividend-paying stocks is less likely to experience price volatility than a growth stock portfolio.

You can increase the dividend-producing holdings in your portfolio in two ways:

• Build a portfolio of owned shares in large companies that have a dividend yield in their stock. Pros are the flexibility of the holdings and a generally lower fee for management of the portfolio. Cons are that they are riskier and take time and expertise to manage.
• Invest in a dividend mutual fund or a dividend-based managed account. The pros of this approach are the opposite of individual holdings. They tend to have a lower risk profile, are expertly managed, and do not require much time on your part. If reducing risk is an important aspect for you, you could also invest in a managed account, which combines dividend-paying stocks with bonds and other income-producing investments for diversification. There is, however, a fee for this service.

Conclusion

Dividend-producing investments and managed accounts can be excellent vehicles to lower your risk level while generating income that is tax preferred. As we get older and count on our portfolio as a means of supplementing our income, dividends could be the answer. If you would like to explore how a dividend portfolio could help you, please call our office for an appointment.