I have invested my registered retirement income fund in dividend stocks with a minimum yield of 4.5 per cent. I am not looking for any substantial increase in share values as long as the dividends are secure and growing. I used to own Fortis Inc. (FTS), Algonquin Power & Utilities Corp. (AQN) and Canadian National Railway Co. (CNR) but sold them because the yields were too low for my plan. Am I being too short-sighted in ignoring share price appreciation as a factor in my overall returns?
I don’t know what your rationale is for setting a minimum yield of 4.5 per cent, but with such a high bar you are excluding a lot of great dividend-paying companies, including many banks, insurers, utilities, power producers, railways and real estate investment trusts. And, yes, share price appreciation often accounts for an even larger portion of a stock’s total return, so you might consider lowering your yield threshold to give yourself more flexibility in choosing stocks.
Another option is to supplement your dividend stocks with exchange-traded funds that track the major Canadian and U.S. indexes. The yields on most index ETFs aren’t huge – the iShares Core S&P/TSX Capped Composite Index ETF (XIC), for example, pays about 2.7 per cent, and yields on an S&P 500 ETF are even lower – but the added diversification, including exposure to lots of growth-oriented companies, should help your returns over the long run.
Which is taxed more favourably, capital gains or dividends?
It depends. At low income levels, dividends are the clear winner. In several provinces, if your income is below a certain threshold ($49,020 in Ontario, for example) your marginal tax rate on dividends will be negative thanks to the dividend tax credit. You won’t get a refund for the negative tax, but it will offset your other taxes owing.
At progressively higher income levels, however, the relative advantage of dividends over capital gains narrows and eventually disappears. When taxable income reaches $98,040 in Ontario, for example, capital gains (which are effectively taxed at half of one’s marginal rate) get more favourable tax treatment. The difference is most pronounced at income of more than $220,000, when the marginal tax rate on capital gains is 26.76 per cent, compared with 39.34 per cent for dividends. (Want to know your marginal tax rate on different types of income? TaxTips.ca has detailed tax tables for all provinces and territories.)
Why do you omit the tax on dividends when publishing returns of stocks you recommend? Taxes affect returns materially and leaving them out seems misleading.
Marginal tax rates on dividends vary widely depending on an individual’s income level and province. As the Ontario example above illustrates, one person might pay no tax on dividends, while another could pay as much as 39.34 per cent – with many different rates in between. Marginal tax rates on capital gains and interest also vary. Moreover, the same person might be in one tax bracket this year and a different tax bracket next year. So it’s not practical to deduct taxes from published returns for stocks. That’s also why mutual fund and ETF companies publish their returns on a pre-tax basis.
The worst move I made last year was exchanging my Brookfield Infrastructure Corp. (BIPC) shares for Brookfield Infrastructure Partners LP (BIP.UN) units. Since BIPC started trading on March 31, 2020, it has gained about 85 per cent compared with 23 per cent for BIP.UN. Why did you retain BIP.UN in your model dividend portfolio and not jump on the winning horse?
First, a correction: The return you cited for BIP.UN is not correct; I suspect it’s because the source of the data didn’t adjust BIP.UN’s price for the unit split that created BIPC last year. BIP.UN’s actual return from March 31, 2020, through April 22, 2021, was about 32 per cent, or 36.4 per cent including dividends. That’s a good return, by the way – just not as good as BIPC’s.
If it’s any consolation, I’m sure a lot of people are kicking themselves for not selling BIP.UN and buying BIPC. But dwelling on what could have been is unhelpful: People make decisions based on information available at the time, and they don’t always get it right. Who hasn’t missed out on a multi-bagger, sold a stock too soon, sold too late or gotten sucked in by a stock with a great story that didn’t pan out as hoped?
It’s unrealistic to expect that every investing decision will be a great one. But if you buy high-quality companies, stay diversified, resist the urge to trade and, above all, exercise patience, you will do just fine over the long run. You’ll also be less rattled when, inevitably, something doesn’t go your way.
E-mail your questions to email@example.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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