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Consider dividends for long-term returns

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(Special) - Besides being a potential source of an income that rises over time and protection against inflation, dividends also can provide investors with good long-term total returns and favourable tax rates.

With Canada's population aging and moving into retirement, two of the issues that are increasingly preoccupying investors are uncertainty about the direction of financial markets and the need for an income stream.

Canadian investors, therefore, are looking in increasing numbers to dividend-paying companies and Dividend Reinvestment Programs (DRIPs) for their returns and stability as an investment.

For one thing, dividends are a good gauge of a company's financial health. The biggest payers of dividends usually are banks and financial institutions. Dividends can pay up to about four or five per cent or more, a better return than investors often can get today from a money market funds or Guaranteed Investment Certificates.

Dividends generally provide a safety net in a weak market and keep the stock attractively valued.

According to Edward Jones dividends, when reinvested, contributed more than 50 per cent of the S&P/TSA composite index's total returns over the past 30 years. Dividend-paying stocks outperformed non-dividend paying stocks over the last 10 years and companies that raised their dividends generally performed even better.

DRIPs allow investors to invest their cash dividends by purchasing additional shares or fractions of shares on the date the dividend is paid without broker fees or commissions. Some companies even offer a discount on the price of their shares.

DRIPs offer investors the opportunity to reinvest their dividend payments regularly, which is particularly appealing in periods of market volatility. "They are a great way to take advantage of dollar cost averaging (averaging out the price at which stock is purchased as its price moves up and down over time) and are a significant strategy for compounding wealth," says Edward Jones adviser Audrey McFarlane.

DRIPs are flexible by nature. Investors can invest either small or large amounts, usually starting with as little as $100.

Companies like to offer DRIPs because they encourage a stable shareholder base that typically has a long-term investment style. DRIP investors are less likely to sell their shares when markets go down because they end up purchasing them at lower prices.

Investors also can purchase dividend growth mutual funds. These funds give investors the option to take the distribution payouts or reinvest them.

Many Canadian investors also are purchasing global dividend funds to improve the diversity of their portfolios and minimize risk.

The Canadian equity market is heavily weighted to banks, financial institutions and companies in the energy and materials sectors, but is not considered to have the diversity of choice to let investors build a truly diversified portfolio.

DRIPs also have some tax advantages.

Eligible dividend income and capital gains are taxed at a more favourable rate than interest income. In other words a dividend-paying stock of mutual fund is more tax advantaged than a bond of GIC.

Combined top federal and provincial marginal tax rates on interest income, capital gains and dividend income can vary quite a bit province by province. In Alberta and the Yukon, for example, dividend income is taxed at a lower rate than capital gains, making dividend-paying stocks and mutual funds a wise choice.

Dividend and other income could negatively affect seniors who are receiving lots of government benefits such as the Old Age Security.

"Every investor's situation is unique, so you should consider consulting with a financial adviser to determine which dividend-paying investments can help you meet your long-term financial goals," McFarlane says.

Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.

Copyright 2014 Talbot Boggs

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