Investing for dividends vs capital growth: smart investors realize that, overall, dividends are more reliable than capital gains.
Capital gains can occur when an investor sells an asset. And for the most part, the capital growth occurs over time.
Dividends are typically cash payouts that serve as a way for companies to share the wealth they’ve accumulated through operating their business. These payouts are drawn from earnings and cash flow and paid to the shareholders of the company. Typically these dividends are paid quarterly, although they may be paid annually or even monthly.
Below we share five tips on investing for dividends vs capital growth that you must know.
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.
Investing for Dividends vs Capital Growth: Dividend investing focuses on long-term success
Dividends are an important contributor to your long-term gains, and dividend-paying stocks tend to expose you to less risk than non-dividend-payers. That’s why the majority of your stocks should be dividend-payers. As you get older and closer to retirement, you should consider raising the proportion of dividend-paying stocks in your portfolio, to cut risk and improve the stability of your investment results.
Companies with long-term success are the most likely to keep paying and increasing their dividends.
Investing for Dividends vs Capital Growth: Dividend-paying stocks can better weather volatile environments
When investing, we think you will profit more from focusing on companies that have maintained or raised their dividends during both economic and stock market downturns. These firms have proven themselves able to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.
Diversification also helps with volatility. No matter what kind of stocks you invest in, you should take care to spread your money out across the five main economic sectors: Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.
By diversifying across most if not all of the five sectors, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or investor fashion. You also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average.
Investing for Dividends vs Capital Growth: Dividend stocks can provide regular income
Canadian dividend stocks offer capital-gain growth potential, but even more important they provide 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.
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 around 25% on dividends, compared to 50% on interest income). Investors in the higher tax bracket pay tax on capital gains at a rate of 29%.
Investing for Dividends vs Capital Growth: Dividends are more reliable than capital gains
Dividends are far more reliable that capital gains. A stock that pays a $1 dividend this year will probably do the same next year. (It may even raise the rate to $1.02.) As well, some investors forget about the wonderful effects compounding interest can have on your portfolio. As a quick refresher, compound interest is earning interest on interest which can have an enormous ballooning effect on the value of an investment over the long term, and lift the overall returns on your portfolio. Dividend payments act in a similar fashion.
All in all, we think that dividends can contribute up to a third of your long-term investment returns, even without the tax-cutting effects of the dividend tax credit.
Bonus Tip: Investing for Dividends vs Capital Growth: You choose when to pay capital gains
One of the main advantages of the Canadian capital gains tax over other forms of investment income is that you control when you pay capital gains tax. This amounts to a very simple and highly effective way of deferring tax—and it’s perfectly legal.
You pay capital gains tax on a stock only when you sell, or “realize” the increase in the value of the stock over and above what you paid for it. In contrast, interest and dividend income are taxed in the year in which they are earned.
Learn everything you need to know in
'7 Winning Strategies for Dividend Investors'
FREE Special Report from The Successful Investor.
The Best Canadian Dividend Stocks to Buy:
REITS Canada and other Top Canadian Dividend Stocks.
Get Your FREE Report Now:
7 Winning Strategies for Dividend Investors
X No, I don’t want to make steady income from dividends.
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