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So what is a dividend fund?
A dividend is a cash payment made to stockholders using net profits from a company's day-to-day operations. The decision to pay a dividend is made by a company's board of directors, which may decide to increase or decrease the dividend, or stop paying a dividend at any time. Companies that pay their shareholders dividends are typically large, established businesses that reside in mature sectors of the economy. For these companies, the underlying value of their stock may not have the same potential for capital appreciation that smaller, growth-oriented companies can provide. This is because as a company matures, its rate of growth will slow relative to that of smaller companies. When this occurs, the mature company will likely turn to paying dividends in order to either maintain, or increase the value of their stock for their shareholders. Conservative investors typically look for companies that have a history of stable dividend payments that gradually increase in value over time.
In addition to the benefits of owning a security that pays out a regular income stream, dividends enjoy tax benefits as well. Because dividends represent an after-tax payout of earnings from a company to its shareholders, an income tax credit known as the dividend tax credit is available to Canadian investors who earn dividend income through investments in the shares of Canadian corporations. This benefit can be considerable when compared to interest payments made from other income paying investments like bonds and GICs. If an investor were to receive a $1,000 distribution from both classes of investments, their net after-tax profit would be $687 from the dividend, and $536 from the GIC (1*).
For investors who are concerned about volatile markets, dividend-paying securities can provide the shelter they crave without having to give up attractive returns. Over the last three bear market years, the average return on a Canadian dividend mutual fund was 6.1 °/a. This compares very favorably to the average Canadian equity fund that returned a loss of 3.8% (2**). If we go back to 1956, the dividend component from Canadian equity markets has accounted for approximately 60% of total market returns. In fact, Canadian stocks with a dividend have increased three times as much as the 11 % median gains of issues that offer no dividend yield. In U.S. markets, the monthly returns on dividend-yielding stocks have outperformed those that did not pay dividends by an annualized 3.7% over the last 30 years.
If you are considering investing in dividend-paying stocks, mutual funds are an ideal way to get involved. In the not so distant past, conservative investors throughout Canada often built their own small portfolios of dividend-paying stocks to capture income and the potential for capital appreciation. And while these investors often benefited from their conservative approach to equity investing, the small number of individual securities did expose them to unnecessary risks.
Today's mutual fund investor can not only benefit from the expertise of a professional money manager, they can also easily access a diversified portfolio of dividend paying investments. Because there are many factors that can affect the price of a dividend paying stock, an investment in these securities will benefit from the advantages that diversification can provide. For example, any material change affecting a company could influence the market's valuation of the stock. These influences could be industry specific, company specific, an overall change in interest rates, a downgrade from a ratings agency, or a risk arising from other factors that affect the economy as a whole. By purchasing a mutual fund that holds a diversified portfolio of these securities, you can reduce the impact on your investment if an individual security fails to perform.
(1*). Based
on the highest marginal tax rate in Ontario z
With files and material from Manulife Investments
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