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Rob Carrick

How dividends came to dominate our investment portfolios Add to ...

After housing, the hottest thing in personal finance is dividend stocks.

Even as interest rates remain stuck near historical lows, the amount of investment income received by Canadians has surged in recent years. You can thank dividends for that. More and more, they’re the go-to vehicle for retirees and others who want investment income.

Dividends are not as safe an income source as interest from bonds or guaranteed investment certificates, but that’s not the only concern generated by this shift in investor behaviour. Another worry is how investors will react when dividend stocks take their turn as an out-of-favour investment and fall in price. There will be a temptation to sell, even if it’s probably the wrong thing to do.

Statistics Canada says that tax filers reported total investment income of $81.6-billion in 2015, the most recent year for which there is data. This flow of investment income into taxable accounts (not tax-sheltered vehicles such as registered retirement savings plans) was up close to 20 per cent from 2014, an increase that was mainly driven by dividends from Canadian corporations.

Back in 2000, the amount of investment income reported by tax filers was $31.8-billion. Since then, the yield on the five-year Government of Canada bond has fallen to 1.1 per cent from 6.2 per cent.

It couldn’t be easier to better today’s returns on bonds and GICs through dividend stocks such as BCE Inc., with a yield around 4.8 per cent; Telus Corp., with a yield around 4.4 per cent; Enbridge, with a yield near 4.6 per cent; and, Bank of Nova Scotia, with a yield around 4.1 per cent.

And yet, the number of tax filers claiming investment income has actually fallen almost 12 per cent since 2000 – to roughly 7.5 million from about 8.5 million. A lot of analysis has been done in recent years on the extent to which Canadians pulled back from investing after the financial crisis and stock market crash of 2008-09. The declining number of people with investment income suggests a substantial number of people might be parking money in safe places such as a savings account.

Dividend stocks have long been a foundational investment, so the surge in popularity hasn’t come out of nowhere. But the extent of today’s dividend domination is still a surprise. Statistics Canada includes dividends as part of its tally of “property income” for households and investment entities such as pensions and life insurance companies. Dividends accounted for a bit less than 20 per cent of this income in the early 1980s, and interest-paying assets produced 80 per cent. More recently, the two have been roughly equal.

Dividends have tax advantages over bond interest in non-registered accounts through the dividend tax credit. Add the much higher yields from dividends over bonds and you have what seems to be a logical, sound shift in investment behaviour.

Investing never offers better returns at no cost, though. Dividends are not as secure as interest paid from bonds issued by either governments or corporations. In a recession, a company might suspend or cut dividends to shareholders while maintaining interest payments to bondholders.

You can manage this risk, though. Limit exposure to dividend payers in sectors such as energy and mining, where dividends may rise and fall with resource prices. Focus on companies with proven, sustainable businesses that have a track record of paying steady or, better, growing dividends from year to year.

The one risk you can’t avoid if you’re big into dividend stocks is falling stock prices. Every dividend stock is susceptible. Utility, pipeline, telecom and real estate stocks would be vulnerable if interest rates rose, while a recession or housing market pullback could hurt financials and industrials.

People 65 and older represent the largest block of income investors at 33 per cent in 2015, while those 55 to 64 represent another 26 per cent. These people may depend on dividend income, so the safety issue has to be confronted.

Savvy investors understand that for quality dividend stocks, declining prices are a non-story at worst and a buying opportunity at best. As long as you get your dividend as an income-seeking investor, what’s the big deal?

Don’t just nod your head in agreement here. It’s inevitable that some investors loaded with dividend stocks will lose confidence in a market downturn and want to sell in order to buy bonds or GICs. If dividends dominate your portfolio, you have to be able to resist this temptation.

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Dividends rule

The number of tax filers claiming investment income has fallen over the past two decades, but the total amount of investment income has soared. How is that possible when interest rates have fallen hard over this period? Dividend investing has more than filled the gap.

 

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Follow on Twitter: @rcarrick

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