Like many of my fellow Fools, I’m an avid fan of dividend investing. Not only does it provide investors with the means to generate a steadily growing, recurring income stream, but time and again it has proven to be one of the best means of attaining investing success.
Let me explain.
Firstly, investing in reliable dividend-paying stocks reduces investment risk.
You see, dividends are commonly paid by companies with mature, stable businesses, reliable cash flows, and wide economic moats. Management is also forced to operate with greater discipline to maintain long-term earnings growth and ensure the sustainability of dividends.
These characteristics all work together to make those businesses less susceptible to economic downturns and market declines.
This becomes apparent when considering the performance of Canadian National Railway Company (TSX:CNR)(NYSE:CNI). It has a solid track record of creating value for shareholders and has paid a steadily growing dividend for the last 16 years straight. Canadian National has been able to achieve this because its earnings are protected by its wide economic moat and the fact that freight rail remains the most cost-effective means of bulk cargo transportation.
Secondly, dividends give investors access to the magic of compounding.
One often-overlooked advantage of dividend investing is the ability to enjoy the benefits of compounding, thereby enhancing returns. Many companies offer investors the ability to reinvest dividends through share-purchase plans, which is an ideal means for investors increase their stock holdings and access the power of compounding.
The advantages this offers becomes obvious when considering Canada’s largest bank by assets Toronto-Dominion Bank (TSX:TD)(NYSE:TD). Had an investor invested $1,000 in the bank 10 years ago and taken the dividends as cash, they would have received a total of $2,372.42, giving them a return of 137%.
However, had they reinvested the dividends through the bank’s dividend-reinvestment plan, or DRIP, they would now have $2,794.60, which is a return of 179%. This is significantly higher than the yield received when taking the dividends as cash, highlighting just how powerful compounding can be.
Finally, dividends provide a tax-effective form of income.
The majority of Canada’s major companies, including Canadian National and Toronto-Dominion, pay what are known as eligible dividends. This means that those dividends are paid out of taxed corporate profits, entitling the recipient to receive tax concessions on that income to prevent double taxation.
As a result, eligible dividends provide investors with a tax-effective income stream, and they are typically taxed at a lower rate than either interest or employment income. This enhances overall returns and makes dividends an attractive form of income.
Dividends may not be popular with every investor; nonetheless, what is clear is that dividend-paying stocks offer a number of advantages that helps to boost the returns received by investors, increasing their chance of achieving investing success.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Matt Smith has no position in any stocks mentioned. David Gardner owns shares of Canadian National Railway. The Motley Fool owns shares of Canadian National Railway. Canadian National Railway is a recommendation of Stock Advisor Canada.