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INVESTOR CLINIC

Just starting out? Dividend ETFs are worth a look Add to ...

I have about $20,000 to invest. Is this an acceptable sum to start a dividend portfolio?

Sure. Before you invest, however, consider paying down any high-interest debt that you may have. Doing so will provide a guaranteed return equal to the rate on the loan.

Once you’ve done that, you can think about investing.

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If you are just starting out, you might consider buying an exchange-traded fund (ETF). I compared several dividend ETFs in a previous article. ETFs have reasonable fees, provide good diversification and can be bought and sold just like stocks.

Managing a portfolio of individual stocks takes more work, but it will cut your costs even more. However, you might consider waiting until you have a larger sum to invest so that you can build a properly diversified portfolio of companies. In the meantime, ETFs are an excellent choice.

Some brokers offer commission-free ETF trades, with some restrictions, as I discussed here. Whatever option you choose, it’s important to keep your fees down. You’ll find some tips here.

I have some shares of BCE and I’m waiting for the ex-dividend date to sell them. I also had some Rogers shares and sold them after the dividend to buy BCE. My question: Is this good to do, this back-and-forth thing between dividend dates?

If only making money were that simple. Unfortunately, there is no free lunch – or free dividend – with investing.

The problem with your strategy is that, all else being equal, on the ex-dividend date the price of a stock will fall by the amount of the dividend. That’s because investors who buy on or after the ex-dividend date aren’t entitled to receive the next dividend payment, and the market price will adjust accordingly.

So – again, all else being equal – if you wait until the ex-dividend date to sell you will get a lower price than if you had sold prior to the ex-dividend date. The price reduction will cancel out the benefit of receiving the dividend, so you will be no further ahead.

In fact, your strategy could end up costing you money. For one thing, you’ll be paying commissions for all those trades. For another, in a non-registered account, you could face capital gains taxes on your sales.

In my opinion, buying and holding high-quality stocks with rising dividends is a more effective strategy than trying to trade in and out in search of a quick profit. It’s also less stressful.

Why are all company expenses – such as wages and bank and bond interest – paid with before-tax dollars, but dividends must be paid with after-tax dollars? And why are capital gains only taxed at 50 per cent?

“Expenses such as salaries, interest and office supplies are costs you incur to run your business,” says Brian Quinlan, partner with Campbell Lawless Professional Corp. chartered accountants. “Dividends are not an expense of operating your business. They’re a distribution to the shareholders of the after-tax profits.”

Because dividends are paid with after-tax dollars, the shareholder is given a credit – called the dividend tax credit – for the tax already paid by the corporation. The result is that dividends are taxed in the investor’s hands at a lower rate than interest or other income. Without the credit, dividends would be taxed twice.

The reason only 50 per cent of capital gains are included in income is that the government wants to encourage investment in assets – such as real estate or stocks – that grow in value, Mr. Quinlan says.

The capital gains inclusion rate hasn’t always been 50 per cent. Before 1972, it was zero per cent. In the 1990s it got as high as 75 per cent, before falling back to 50 per cent, where it has been since 2000, Mr. Quinlan says.

Follow on Twitter: @johnheinzl

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