We think investors will profit most — and with the least risk — by buying shares of well-established, dividend-paying stocks with strong business prospects.

These are companies that have strong positions in healthy industries. They also have strong management that will make the right moves to remain competitive in a changing marketplace.

Here are 3 ways dividend paying stocks can help improve your portfolio’s long-term returns:

1. Growth and Income: The best Canadian dividend stocks offer both capital gain growth potential and regular income from dividend payments. In fact, dividends are likely to still be paid regardless of how quickly the price of the underlying stock rises.

2. Greater safety: A dividend-paying company with a long-term record of dividends provides a measure of safety for investors. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake — either the company has the cash to pay dividends or it doesn’t.

That’s not to say that there won’t be surprises that affect every company in a particular industry. But well-established, dividend-paying stocks generally have the asset size and the financial clout — including solid balance sheets and strong cash flow — to weather market downturns or changing industry conditions.

The Growing Power of Dividends Learn everything you need to know in '7 Winning Strategies for Dividend Investors' for FREE from The Successful Investor. The Best Canadian Dividend Stocks to Buy: REITS Canada and other Top Canadian Dividend Stocks.  I consent to receiving information from The Successful Investor via email. I understand I can unsubscribe from these updates at any time.

3. Favourable tax treatment: Taxpayers who hold Canadian dividend stocks get an additional bonus. Their dividends can be eligible for the dividend tax credit in Canada. This means that dividend income will be taxed at a lower rate than the same amount of interest income (investors in the highest tax bracket pay tax of 23% on dividends, compared to about 46.4% on interest income). Investors in the highest tax bracket pay tax on capital gains at a rate of roughly 25%.

Looming income trust tax gives dividend paying stocks greater appeal

Well-established stocks that pay dividends should gain investor appeal as Ottawa’s income trust tax approaches. This new tax, which comes into effect on January 1, 2011, will put trusts on an equal footing with corporations.

Right now, trusts pay out a high percentage of their cash flows to their unitholders. This lets them avoid paying corporate taxes. It also gives many of them significantly higher yields than a lot of dividend-paying common stocks.

The new tax will eliminate these income-tax benefits. That could attract more income-seeking investors to dividend paying stocks like BCE Inc. (symbol BCE on Toronto), which is Canada’s largest telephone service provider. BCE is one of the stocks we cover in our Canadian Wealth Advisor newsletter.

BCE just raised its quarterly dividend by 7.4%, to $0.435 a share from $0.405. The new annual rate of $1.74 yields a high 6.0%. This is the company’s third dividend hike since a proposed $42.75-a-share takeover offer led by the Ontario Teachers’ Pension Plan fell through over a year ago.

Dividends can provide up to a third of your portfolio’s total return

A couple of decades ago, you could assume that dividends would contribute up to a third of your long-term investment returns, without even considering the tax-cutting effects of the dividend tax credit (see above).

Earlier in this decade, dividend yields were generally too low to provide a third of investment returns. But now that yields have moved up, it’s realistic to assume they will once again contribute as much as a third of your total return.

For our latest buy/sell/hold advice on dividend paying companies (including BCE) and other safety-conscious investments, you should subscribe to our Canadian Wealth Advisor newsletter. Click here to learn how you can get one month free when you subscribe today.