PETER DOLEZAL: The growing importance of portfolio dividends

Dividends have always played a major role in the growth of successful investment portfolios.

Dividends have always played a major role in the growth of successful investment portfolios. Over the 25-year period ending in 2011, the TSX Index delivered a respectable average annual return of 6.9 per cent. Had one invested however, in only the dividend-paying stocks in that same Index, the annual return would have increased to10.5 per cent. Had the investments been exclusively in those companies which not only paid dividends, but also increased them annually, the annual return would have been 12.2 per cent.

By gravitating toward the dividend-paying and dividend-growing segment of an equity index, the investor is not only selecting the cream-of-the-crop, but is also lowering his market risk.

This impressive contribution of dividends to total portfolio returns should never be ignored. This is particularly so now, given both the current and foreseeable future of tepid market capital gains. If, over a long-term period such as a decade, an investor can be assured for example, of a 3.5 per cent annual dividend income stream, then the portfolio needs only to average three per cent annually in capital gains, in order to deliver a respectable 6.5 per cent annualized return. An expectation of three per cent annual capital gains over a decade is a very conservative objective by any historical measure.

If the dividend-generating equities are Canadian, and held in a Non-Registered account, they deliver the added benefit of attracting extremely low tax rates on the income received.

It is also important to note that high-quality Canadian Preferred Shares which deliver a much higher annual dividend yield than do bond interest payments, also attract preferential tax treatment. While preferred shares are slightly higher on the risk-scale than bond holdings, they are, if sufficiently diversified, often considered as fixed-income investments and can be virtually as safe as bond holdings.

With the short-term volatility of equity markets over the past few years, it is comforting to know that regardless of market direction, your portfolio can continue to benefit from a steady and predictable dividend-based income stream — a great way to be paid while waiting for the market’s longer-term capital appreciation.

The prudent investor must as always, ensure that he is not receiving a nice 3.5 per cent dividend stream only to at the same time incur a holding cost of several per cent, as is the case with most mutual funds. If one limits equity holdings to Index Funds or Exchange-Traded Funds (ETFs), concentrating on the dividend-payers and dividend-growers, a net, predictable 3.5 per cent annual income stream can be realized.

These facts are so compelling that every prudent investor should carefully take them into account when formulating an investment strategy.

A retired corporate executive, enjoying post-retirement as a financial consultant, Peter Dolezal is the author of three books. His most recent, The Smart Canadian Wealth-Builder, is now available at Tanner’s Books, and in other bookstores.