07/24/2015 12:33 EDT | Updated 07/28/2016 05:59 EDT

Why Dividend Stocks Dominate My Portfolio

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I love my friends. Most are kind, two are funny. Three are generous, and another is shrewd. But my BFF? That friend would be my dividends.

Not clear on exactly what dividends are? 

When you buy shares in a company, you become an owner of that company. For example, if ABC Widgets has 10,000 shares outstanding, and you buy 1000 shares, you own 10 per cent of the firm. In a perfect world, ABC Widgets will have plenty of revenues. After expenses and taxes, there will be a remaining pile of money, which is called income.

Companies have several choices of what to do with these funds. Many will reinvest much of the income back into the business itself. This reinvestment can include the creation of new products, hiring more staff, update computers, etc. However, many of these companies will return a portion of earnings to the shareholders.

That's you, and these are dividends.

If ABC Widgets declared for 2015 the dividend would be $1.04 per share (paid quarterly), and you still have your 1000 shares, you can expect to receive $260 every three months. At the end of 2015, in addition to any gains (or losses) in the price of the stock, $1,040 would have been deposited to your bank account. In cash.

Why Dividend Stocks Dominate My Portfolio

• Studies have proven stocks that pay dividends outperform stocks that do not pay dividends. What does this mean? Some investors prefer growth stocks over dividend paying stocks. The theory being that a firm that reinvests 100 per cent of income (as opposed to only 90 per cent) into the company grows faster. And over time, this growth would result in a higher stock price. As I said, history has shown these investors to be wrong: dividends have accounted for over 42 per cent of total stock market return since 1930 .

• While I support reinvesting your dividends back into stock purchases (called Dividend Reinvestment Plan, or DRIP), there is a tremendous benefit having your new BFF give you money in the form of cash. This benefit would be having access to extra income when needed. Many a wise and wealthy woman is living comfortably today on a pension supplemented by dividend income from stocks she bought in her forties.

• When investors invest in Canadian stocks, the government is happy. Accordingly, the government has mandated that you will pay less tax on income you receive in the form of dividends. So now your new BFF is not just depositing money into your account on a regular basis, but the government is letting you keep more of that money.

Still not convinced?

A significant number of dividend paying companies in Canada have a long history of increasing the dividends they pay to shareholders. Many of these firms have raised their dividend almost each and every year. Can you imagine? A BFF that just keeps on giving?

My proposition to you is that you start to invest. And high-quality dividend stocks with a track record of increasing their dividend payouts are a fantastic place to start.

Choose your friends and your stocks wisely.


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