Why Dividends Need To Be Your New BFF
Welcome to the BONUS lesson of Investing Bootcamp!
I love my friends. Most are kind; two are funny. Three are generous, and another is shrewd.
But my BFF? That friend would be my dividends.
Haven’t been introduced to dividends yet?
As you might remember from Lesson Four, if an investor purchases shares in a company, she becomes an owner of that company. As a refresher, if The Awesome Lipstick Company has 10,000 shares outstanding, and your Aunt Beatrice buys 1000 shares, she then owns 10 percent of the firm.
In a perfect world, The Awesome Lipstick Company will have plenty of revenues. After expenses and taxes, there will be a remaining pile of money, which is called income.
Companies have several choices of what to do with these funds. Many firms will reinvest much of the income back into the business itself. This reinvestment can include the creation of new products (eyeshadow?!), hiring more staff, update computers, etc.
However, many of these companies will return a portion of earnings to the shareholders.
That’s Aunt Beatrice, and these are dividends.
If in 2017, The Awesome Lipstick Company declared a dividend for $1.04 per share, and Aunt Beatrice continues to hold her 1000 shares, she can expect to receive $260 every three months. Meaning, at the end of 2017, in addition to any gains (or losses) in the price of the stock, $1,040 would have been deposited to her bank account. In cash.
Why Dividend Stocks Dominate My Portfolio
Studies have proven stocks that pay dividends outperform stocks that do not pay dividends. What does this mean? Some investors prefer growth stocks over dividend paying stocks. The theory being that a firm that reinvests 100 percent of income (as opposed to only 90 percent) into the company grows faster. And over time, this growth would result in a higher stock price. As I said, history has shown these investors to be wrong: reinvested dividends have accounted for 41.8% percent of total stock market return since 1930.
While I support reinvesting your dividends back into stock purchases (called Dividend Reinvestment Plan, or DRIP), there is a tremendous benefit having your new BFF give you money in the form of cash. This benefit would be having access to extra income when needed. Many a wise and wealthy woman is living comfortably today on a pension supplemented by dividend income from stocks she bought in her forties.
When investors invest in Canadian stocks, the government is happy. Accordingly, the government has mandated that you will pay less tax on income you receive in the form of dividends. So now your new BFF is not just depositing money into your account on a regular basis, but the government is letting you keep more of that money.
Still not convinced?
There is a long list of companies in Canada with a history of increasing the dividends they pay to shareholders. Many of these firms have raised their dividend almost each and every year.
Can you imagine? A BFF that just keeps on giving?
My advice to you is that you start to invest. And high-quality dividend stocks with a track record of increasing their dividend payouts are a fantastic place to start.
Choose your friends and your (dividend) stocks wisely.
TAKE IT TO THE NEXT LEVEL: INVEST LIKE YOU MEAN IT
In Zero to Portfolio, An Investing MasterClass, dividends (together with interest and capital gains) are covered in Module 7. If you have not signed up yet, make sure you do before you make your next investment.
Also, the course lesson covering the exact steps to build your investment portfolio includes both recommended dividend ETFs along with a calculator to measure and track your annual dividend yield.
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- Understanding compound interest
- Introduction to inflation
- Bond (fixed income) basics
- Stocks: Not as risky as you might think
- All about asset allocation
- Mutual Funds. meh.
- Fed up with high fees? Me too.
- Exchange Traded Funds—oh yeah.
- RRSP or TFSA?
- Bonus Lesson: Dividends
The Fine Print:
Investing Bootcamp is provided as an educational resource and should not be construed as individualized investment advice, nor as a recommendation to buy or sell specific securities. The investments and scenarios discussed in the course are examples only and may not be appropriate for your individual circumstances.
The investing strategies presented in Investing Bootcamp will result in losses during any period of decline in the broad stock and bond markets. All investments carry the risk of loss. It is the responsibility of individuals to do their own due diligence before investing in any index fund or ETF mentioned in this course.