Dividend aristocrats boost your income and capital

Canadian Dividend aristocrats are stocks that have raised their dividends for at least five years in a row. These growing income streams increase your stocks’ attractiveness and are likely to boost their share prices. Canadian dividends also face lower income tax rates than interest income.

In Canada, dividend aristocrats are stocks that have raised their dividends for at least five years in a row. Such stocks suit income-seeking investors, of course. Dividend aristocrats also suit investors seeking share price gains. That’s partly because income-seeking investors typically bid up the shares’ prices.

Dividends beat interest and help fight inflation

Retirees usually have two main investment goals: first, to earn income to support their lifestyles; second, to safeguard their capital. They cannot afford to suffer catastrophic losses. That’s why many retirees buy fixed-income investments, such as bonds.

Today, however, the dividends of many high-quality stocks yield more than government bonds. The last time this happened in North America was in the 1950s. In Europe, credit-worthy government bonds carry negative yields. So it makes sense to buy dividend aristocrats for higher and growing income.

Some retirees overlook the risk of inflation. In the year to October 31, the Consumer Price Index rose by 1.5 per cent. But inflation could accelerate due to four factors:

1. U.S. president Donald Trump plans to invest $1 trillion in infrastructure and to cut income taxes. This would add to inflation.

2. Major central banks deliberately target inflation of two per cent a year. They’re very frightened of deflation (falling prices).

3. Globalization. Goods and services go to the highest bidders. In the years ahead you’ll compete against more affluent consumers in emerging nations. They already buy more of everything. The partial offset is that lower wages in many countries hold down the prices of manufactured goods.

4. Millions of baby-boomers will retire in years to come. This cohort was followed by smaller generations. Eventually, Canada will have fewer working-age people supporting a growing number of retirees. This could spark inflation, as in the 1970s, when boomers consumed more than they produced. Growing productivity could ease the crunch. The trouble is, productivity is growing slowly.

The argument against bonds

One way to beat inflation is to buy stocks that raise their dividends faster than the increase in your costs. This includes dividend aristocrats.

Bonds offer no protection against inflation. The best that you can hope for is to receive the interest and principal payments when they’re due. But these dollars will buy less as costs rise. If you sell the bonds after interest rates have risen, you’ll lose money. Bond prices will fall until the gains on the face values of the bonds at maturity and the interest payments equal what you would earn from new bonds.

Another disadvantage with bonds is that the interest payments are fully taxed. The only exceptions are if you keep the bonds in a TFSA (Tax Free Savings Account) or in a tax-deferred account such as a RRSP (Registered Retirement Savings Plan) or RRIF (Registered Retirement Income Fund).

Dividends taxed less than interest

By contrast, dividends of public Canadian companies are partly sheltered from income taxes. That’s because the Canadian dividend tax credit reduces double taxation (where the income of the company is taxed and then the investors’ dividends are taxed).

What’s known as ‘reaching for yield’ is risky, that is, buying stocks with very high dividend yields. Most often, a very high yield indicates high risk. One way to reduce this risk is to buy companies that regularly raise their dividends. Your dividend keeps going higher without the risk.

There’s a potential drawback to buying dividend-paying stocks. You must ‘gross-up’ your dividends. If this lifts your income beyond a certain point, your Old Age Security payments will be partly or fully clawed back. Similarly, you could lose payments such as the Guaranteed Income Supplement.

In the U.S., dividend aristocrat refers to companies that have raised their dividends for at least 25 years in a row. They can assist you in achieving better diversification. Many of the world’s leading consumer and manufacturing stocks are American companies.

Be aware of Canadian taxation of U.S. dividends

But American dividend aristocrats do not benefit from the Canadian dividend tax credit. You also typically face a 15 per cent withholding tax on U.S. dividends. One way to avoid this is to hold U.S. stocks in your RRSP or RRIF. There’s no withholding tax on U.S. dividends paid into them.

Higher U.S. interest rates could initially hurt dividend-paying stocks. Then again, interest rates rise when the economy is stronger. This usually raises company profits and share prices. Consider adding to your holdings of dividend aristocrats in 2017.

Here are 37 Canadian dividend aristocrats, stocks that have raised their dividends in each of the last five years, at least.  They are: Agrium, Alimentation Couche-Tard, Atco Ltd., Bank of Montreal, Bank of Nova Scotia, BCE, Canadian Aviation Electric (CAE), CCL Industries, C.I. Financial, Canadian National Railway, CIBC, Canadian Tire, Canadian Utilities, Emera Inc., Enbridge, Finning International, Fortis, Gildan Activewear, Hardwoods Distribution, High Liner Foods, Imperial Oil Ltd., Loblaw Companies, Magna International, Metro Inc., Open Text Corporation, Richelieu Hardware, Royal Bank of Canada, Saputo Inc., Stantec Inc., Stella-Jones Inc., Suncor Energy, Telus Corp., Thomson Reuters, Toromont Industries, Toronto Dominion Bank, Trans Canada Corp., Transcontinental Inc.

 

This is an edited version of an article that was originally published for subscribers in the January 2017/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

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