Managing Risk with Dividends
Want a cushion against market volatility? Looking for tax-efficient income? Stocks that pay dividends can be a valuable addition to your portfolio because they have the potential to dampen volatility, provide tax-efficient income, and enhance your rate of growth.
Given the volatility and uncertainty of the markets and the economy, many are searching for sensible and prudent ways to earn solid returns within a reasonable range. But with interest rates so low, conservative investors who can’t afford to pull their money completely out of the market are in a bind – it’s a challenging time to find consistent investment income.
For those who can tolerate the chance of some volatility for a portion of their portfolio, dividends are a decent way to earn income. Dividends enhance returns without adding risk to your portfolio—not only do you hope to get the rewards of stock price increases over time, but at the same time, you’re paid a dollar amount per share you own in the form of dividends.
Dampening Volatility
Two common categories of investments are (1) growth oriented and (2) income oriented. Either the company takes all of its profits and pumps it back into the company with growth as its primary goal or it shares its profits with you the shareholder in the form of dividends and uses the rest for growth.
Dividend-paying companies, therefore, offer you both the opportunity for growth in the form of increased share price and income in the form of dividends. Typically, the board of directors of a dividend-paying company will attempt to increase their dividends every year at the same rate.
Dividend-paying stocks have a distinct advantage during periods of market volatility. As share prices fluctuate, the dollar amount per share of your dividends stays the same, thus dampening the volatility a bit. That said, the board of directors of a dividend-paying company could reduce or suspend payment of their dividends, so payment is not guaranteed.
Tax-efficiency
The tax treatment of dividend income is compelling. Bonds and GICs pay interest income, which is taxed as if it’s employment income—every dollar is taxed at your full marginal tax rate.
Dividend income, on the other hand, is eligible for the Dividend Tax Credit and results in more money in your pocket. In BC, the highest tax rates are as follows:
Interest: 43.7%
Dividends: 19.9%
Capital Gains: 21.9%
As an investor, the implications are clear: you get to keep more of your investment income if it is earned in the form of dividends than if it is earned in the form of interest. The trade off is that bonds and GICs that pay interest are generally less risky than stocks that pay dividends. This is why it’s important to pay attention to the how much of your portfolio is invested in bonds and how much is in dividend-paying stocks.
Fun stuff isn’t it? If you want to talk about how dividend-paying stocks could play a role in your portfolio, as always, don’t be afraid to call for a quick chat.
Heather Holden, PhD, CIM
Wealth Advisor, ScotiaMcLeod
604-661-1523
Heather_Holden@ScotiaMcLeod.com
