Time to Be Defensive? Don’t Overlook the Power of Dividends

In the excitement of rising markets, dividends have taken a back seat to capital gains in terms of investor focus. At some point, economic growth and market momentum are expected to slow, which may prompt the need for a more defensive strategy — and this is where dividend investing can provide value.

Dividends have historically contributed to the majority of equity returns. Various studies suggest that over the past century, at least 60 percent of North American total equity returns have come from dividends.1 Although recent market trends have seen funds flow towards growth stocks — companies that typically prioritize reinvesting profits back into their operations rather than distributing them — the benefits of dividends remain substantial.

Harness the Power of Reinvestment: Dividend Reinvesting

Reinvesting dividends can dramatically increase overall returns. Since 1985, reinvesting dividends in the S&P/TSX Composite has resulted in triple the return compared to relying solely on price performance (graph, top). A dividend reinvestment program (DRIP) can harness the power of reinvestment by reinvesting dividends (or distributions) received back into the same investment, often in the form of additional shares, instead of receiving cash. Over time, this has the potential to substantially grow the number of shares owned. DRIPs are set up to operate automatically, which can be helpful in taking the emotion out of investing; reinvestment is made at regular intervals steadily building positions over time.

Dividends also provide other benefits, including:

? Reliable income stream. This can be especially beneficial when approaching retirement.

? Potential inflation hedge. Companies that regularly increase dividends over time can help investors keep pace with inflation.

? Reduced volatility. Many dividend payers are mature, stable businesses with predictable cash flows. Dividends can smooth out price volatility, providing a cushion during difficult markets.

? Capital preservation. Many quality companies that consistently pay dividends signal financial stability, supported by robust balance sheets that may better withstand market downturns.

Consider also the potential tax benefits. In non-registered accounts, eligible dividends are taxed at a lower rate than interest or ordinary income, thanks to the federal dividend tax credit.

Years ago, an article in the Globe and Mail titled “How to earn $52,000 tax free — no offshore account required” highlighted a lesser-known advantage of the dividend tax credit: the ability to earn tax-free income from eligible dividends, depending on the province of residence.2 This amount has increased to $55,704 for the 2024 tax year. With no other sources of income, the dividend tax credit and basic personal amount have the potential to reduce taxes on eligible dividends to zero.

While a neat concept, most of us have employment or pension income that would get in the way. It’s worth noting that to generate $55,704 of dividend income at a 4 percent dividend yield, one would need almost $1.4 million in dividend-paying securities in a non-registered account!

In short, I continue to advocate the benefits of quality, dividend-paying securities in supporting investing programs.