The quest for income can lead in many directions. And capital markets offer plenty of tools for the income investor’s needs. But a little planning can make things easier and produce attractive rewards as well.
If you’re about to retire with, say, $500,000 to produce income, your first impulse may be to look at interest rates of GICs of, say, 2.0 per cent and conclude that you’ll have to settle for an income of $10,000 per year, fully taxable.
Some planners, however, may suggest dividend-paying shares or dividend funds for the tax advantages of dividends. Indeed, a dividend of 2.0 per cent will produce the same after-tax income as interest of 2.8 per cent.
Historically, stock markets have tended to factor that into valuations of dividend-paying shares. In other words, the price of dividend-paying shares, especially preferred shares, have tended to be high enough to make the yield comparable, after tax, to corporate bonds.
Bond investing and interest and dividends compared
These days, however, with interest rates as low as they are, a 10-year Bank of Montreal bond yields 3.4 per cent. And a BMO preferred share comes with a dividend yield of about 5.0 per cent, equivalent to interest of 6.9 per cent. You would typically get more for the preferred anyway, since it has less credit seniority.
If, on the other hand, you invest $250,000 of the $500,000 noted above in various GICs yielding 2.0 per cent, you can take $25,230 per year for 10 years, assuming you spend the principal as well as the interest. If you invest the remaining $250,000 in a portfolio of conservative, diversified stock funds and realize 7.0 per cent per year, you’ll have an overall yield of 4.5 per cent — at least to start with. And much of that will be capital gains for income tax purposes.
That 7.0 per cent yield may seem a bit tenuous. After all, stock funds can and do fluctuate wildly in value from year to year. But remember, you have income secured to 10 years. So you can pick and choose when to redeem stock-fund holdings to add to your portfolio of GICs.
Over the pat 10 years, the average Canadian equity fund gained a compound annual 6.3 per cent. And that includes the dismal year of 2008.
Canadian Mutual Fund Adviser •4/17/14 •