Personal Finance

Higher yields, tax advantages, growth potential
By Gail Bebee | 12-20-11

Fewer and fewer Canadians have an employer-sponsored pension waiting for them at retirement. Although many retirees will receive some government retirement benefits, the most a person 65 years or older can collect from Old Age Security and the Canada Pension Plan is about $18,000 (2011 figures).

About the Author
Gail Bebee is an independent personal finance speaker, teacher and the author of No Hype--The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com.

Those with little or no additional pension income must count on their personal savings to supplement these basic benefits. A major challenge for Canadians in this group is how to deploy their savings to generate an adequate ongoing income for the rest of their lives.

Fixed-income assets like guaranteed investment certificates (GICs), corporate and government bonds and cash deliver a dependable and regular income stream from interest payments. However, a retirement portfolio containing only this asset class may not generate sufficient income, especially given today's low interest rates. Of additional concern, the purchasing power of fixed income does not always keep pace with inflation.

Investing a portion of retirement savings in the common shares of successful, dividend-paying companies has the potential to overcome these twin concerns. The dividends provide an ongoing income. There is the possibility of additional inflation-hedging profits if the stock price and/or the dividend payout increase over time. Furthermore, eligible Canadian dividends from stocks held outside a registered account are taxed at a lower rate than interest income.

Preferred shares also pay dividends regularly. However, they do not offer the same opportunities for share price appreciation and dividend growth as common stocks.

Make no mistake; investing in dividend-paying stocks is riskier than buying GICs. Stocks, unlike GICs, rise and fall in price and are not covered by the government-backed Canada Deposit Insurance Corp. So, it's essential to choose these stocks based on a thorough assessment of the company, not just the dividend level. In fact, a company in trouble may have a high dividend yield due to a falling stock price.

Some dividend-paying companies regularly increase their dividends. For instance, the Mergent Broad Canadian Dividend Achievers Index, maintained by a subsidiary of U.S.-based Mergent Inc., consists of Canadian companies that have increased their annual regular dividends for the last five or more consecutive years.

At last count, 16 of the 38 companies in the Mergent index pay investors a dividend that is higher than the best currently available return rate for a five-year Canadian bank GIC, about 2.75%. Among the highest yielding names are the investment manager AGF Management Ltd. AGF.B , yielding 7%; and retailer North West Co. NWC and broadcaster Corus Entertainment Inc. CJR.B , yielding 4.9% and 4.3% respectively.

For risk-management reasons, a well structured portfolio should include several stocks from each of the major economic sectors. To build such a portfolio of dividend stocks, retirees must look beyond the Dividend Achiever companies.

Fortunately, there are a number of excellent Canadian companies that can serve as building blocks for a dividend-income portfolio. Even if they do not meet the Mergent test of having raised their dividends for five consecutive years, they are well established, profitable and currently pay a dividend yield higher than 3%.

Banks figure prominently on this list. For example, Bank of Montreal BMO is currently yielding 5.1%, and CIBC CM is not far behind at 5%. Other dividend-rich candidates that are worth a look include the telecommunications giant BCE Inc. BCE , pipeline utility TransCanada Corp. TRP and Canadian Oil Sands Ltd. COS , a major player in the Alberta oil sands.

For sectors not well represented in the Canadian stock market, such as health care and consumer goods and services, you can use foreign stocks to round out your portfolio. Potential candidates include companies that are constituents of the Mergent US Broad Dividend Achievers Index and/or the Mergent International Dividend Achievers Index. Note that the dividends of foreign stocks do not receive the preferential tax treatment conferred on Canadian dividends.

Not all retirees are comfortable building their own portfolio of dividend-paying stocks. They may prefer a packaged approach to investing, even if it comes at a price.

Fortunately, exchange-traded funds offer a convenient, low-cost alternative. Your choices in ETFs with a mandate to invest in Canadian dividend-paying common stocks include iShares Dow Jones Canada Select Dividend Index (XDV/TSE), Claymore S&P/TSX Canadian Dividend ETF CDZ , BMO Canadian Dividend ETF ZDV and PowerShares Canadian Dividend Index ETF PDC .

Mutual funds are another convenient way to invest in dividend-paying stocks. Management-expense ratios are generally much higher than for ETFs, largely due to the common practice of bundling advisor compensation into the cost to investors. The Canadian Dividend and Income Equity category, where ETFs can also be found, is the place to look for funds that focus on dividend stocks.

Among the mutual funds rated highly by fund analysts are: RBC Canadian Equity Income , the winner in its category at this year's Canadian Investment Awards, and runners-up Dynamic Equity Income and Fidelity Dividend Plus . Another notable fund in this category is BMO Guardian Growth & Income Classic , which has a below-average MER and a top 5-star Morningstar Rating for its past risk-adjusted returns.

The above companies and funds are cited only as examples. Investors should do their own research and/or consult their financial advisors before making a decision to invest.

Including quality dividend-paying common stocks or equivalent investment funds in a retirement portfolio should boost the income generated compared to holding only fixed-income investments. Before pursuing this strategy, retirees should satisfy themselves that the risks involved match their personal risk tolerance and investment goals.

Video Reports
More...
Click here to view all