Week 16 - Dividend Income

It's a two-post week this week. I have to admit; golf season has started so time in the office is a little more sacred, meaning I could slip out a half-hour early here and there for a 4:30pm tee time! That leaves less time for posting and more time for hitting balls into the woods.

I wanted to talk about stocks that pay dividends this week. I know there are a plethora of financial products out there that are great tools for diversification and give you exposure to different parts of the world. That said, we have some of the world's best companies right here in Canada and it is very possible to set up a portfolio of Canadian stocks that pay nice dividends. You can do this by paying an up-front brokerage commission too, which means no annual management fees. You just set it and forget it.

Let's first review what a dividend is: we will use the CIBC as an example. If you buy shares of CIBC, you will receive a dividend every three months. Right now, that dividend is set at $3.48 per year or $.87 each quarter. This $3.48 is a percentage of the profits that CIBC makes that they don't choose to reinvest into their business. They would rather pay out their shareholders and let them decide what to do with the money.

Now let's look at some ways we can take advantage of companies that pay dividends:

DRIPs
Many Canadian companies offer their shareholders the option to reinvest their paid out dividends, often at a discount to the market price of the shares. If you don't rely on the income stream from your dividends, then this is a great way to grow your savings. If you assume that a dividend is 5% of the company's stock price, as an example, then by reinvesting the dividends, you could add 50% over ten years, assuming ZERO growth from the shares themselves. As you can see, that's a great way to save money, without having to add more of your own funds to the pot. DRIP = Dividend ReInvestment Plan.

SWPs
Another route to take if you hold shares at a brokerage is taking your dividends each month and having them electronically transferred from your investment account to your bank account. This is very popular with retirees who would use their dividend income to live off. Usually twice a month, the dividends that have been paid into the account from the stocks, (or interest if they are bonds) are 'swept' out of the investment account and transferred to the bank account. It's that easy. SWP = Systematic Withdrawal Plan.

Piece of Mind
I think the nicest part about dividends is that they help ease the pain of bad markets. If you know you are going to collect your dividends every month or quarter, you are less likely to care what your stocks are doing. That can help you stay invested, when it might otherwise feel difficult. If you sell, then you don't get your dividends anymore and you might miss the upswing of the next good market.

Tax Treatment
Dividends are nice too because our government offers preferred tax treatment over regular income. This results in about half as much tax to pay on your dividend paying stocks, compared to your bonds. So if you have a stock that pays a dividend equal to 5 % of the share price, you'd have to find a bond that paid 7.5% interest to get the same after-tax income. With interest rates as low as they are today, 7.5% bonds are not easy to come by.

Hopefully you see how nice a portfolio of good dividend paying stocks can be, if managed properly. You just buy the stocks, make one or two changes a year and collect the dividends. Life is good. Have a great week.