Dividend investing for Canadians

I have been dividend investing for about 10 years and my strategy has evolved over the years from a couch potato portfolio of TD e-series index funds to individual stock selections. Both are good approaches to dividend investing, although I have had a strong leaning towards dividend stocks in the last four or five years, instead of index funds.

What I like most about index funds in the diversification. What I like most about dividend stocks is the ability to narrow down the playing field and purchase stocks when they are on “sale”, or at the very least are fairly valued.

Maximize Tax Sheltered Accounts

One of the best ways of significantly growing your investments is by allowing them to compound tax free. For that reason, most people should be maximizing your TFSA and RRSP contributions. I think that the TFSA should be focused on first, especially for those in lower tax brackets. If you are at the start of your career and you have to choose between the TFSA and RRSP, go with the TFSA and save that RRSP contribution room for later in your career when you are in a higher tax bracket.

Buy What You Know

If you are buying individual dividend stocks, I think one of the best things you can do is to buy what you know. Buy stocks in brands or companies that you are familiar with, as this will help you understand the business you are investing in. The advantage to investing in companies you actually use is that you have an opportunity to do some real world investigating. Back in 2007 I was traveling in Vietnam and was on a boat in Ha Long Bay. There were two photography students on that trip, one who shot with a DSLR camera and one who shot with traditional film. I listened to them debate DSLR vs film and they both had some good points. But of the about 20 people on that boat trip, 100% of people other than the one photography student had a digital camera. It was around this time that Kodak, although they did have digital camera sales, were continuing to push the film camera. It was obvious to me at the time that they were making the wrong decision, so this is a clear case where if I was going to make an investment, it would not be in Kodak but would be in Sony, Canon, or Nikon (Kodak would later file for chapter 11 in 2012). Thinking about investing in a food chain? Do they have a location in your city? Visit it! Check out the foot traffic at lunch and dinner to help you get a feel for how popular it is in your own city.

Allocations

There are tax advantages to holding each asset class in various accounts, which I will outline below.

US stocks have a 15% withholding tax on the dividend, so the best place to keep US stocks is in your RRSP since we have an agreement with the US government to not collect the 15% withholding tax when the stock is held in an RRSP. You can actually claim the withholding tax as a tax credit if held in a non-registered account, so that would be option #2. Did you know that most RRSP accounts can hold both CAN and US dollars (Questrade was the first to do this)? That means if you setup your RRSP account to keep the dividends received in the currency it was received in, there is no conversion fee. In addition, when you are buying more US stocks, you can use the US dollars accumulated in your brokerage account and save on additional currency fees.

Canadian stocks that pay an eligible dividend receive favourable tax treatment due to the enhanced dividend tax credit when they are held in a non-registered account. This basically means that you will pay less tax on the dividends earned. If held in an RRSP or TFSA, there is no enhanced dividend tax credit. I would hold Canadian stocks in your TFSA as no taxes are paid on the dividends withdrawn and then in your non-registered account if both your TFSA and RRSP’s are maxed.

Bonds get taxed as regular income (at the highest rate essentially) so you should really try to only keep bonds and GIC’s in your RRSP or TFSA.

Real Estate Income Trusts (REITs) can get tricky when calculating your cost basis, especially if you use a dividend reinvestment plan. For that reason, keep the REIT’s in your RRSP or TFSA as it will simplify taxes.

TFSA

Canadian dividend paying stocks
Bonds and GIC’s
REIT’s

RRSP

US Dividend paying stocks
Canadian dividend paying stocks
REIT’s
Bonds and GIC’s

RESP

Canadian dividend paying stocks
Bonds and GIC’s

Non-Registered

Canadian dividend paying stocks
US stocks that do not pay dividends

Dividend Reinvestment Plan (DRIP)

A DRIP plan is an automatic re-investment of the dividend paying back into the stock. So if you were paid a dividend by Canadian Imperial Bank of Commerce (CIBC) of $200, the drip plan would automatically purchase as many shares as you could with $200. If CIBC (symbol: CM) is trading for $100.00, the drip plan would purchase 2 shares of CM for you, with no commission fees. If CIBC is trading for $110, the drip plan would purchase 1 share of CMfor you and the remaining $90 would remain in cash. This is referred to as a full or regular DRIP. There is also a synthetic DRIP that will purchase partial shares, thereby fully investing the dividend for you (TD does this with their e-Series index funds).