Canadians are searching for ways to ensure they have enough money to support a comfortable retirement.
One strategy involves owning dividend stocks inside your RRSP and investing the distributions in new shares. This sets off a powerful compounding process that can turn a modest initial investment into a decent savings fund over time.
Contributions to your RRSP can be used to reduce your taxable income, and the amount you can put in the RRSP depends on your income level as well as the RRSP room you have available from prior years.
While the funds are sitting in the RRSP, the distributions and capital gains are not taxed. You only pay tax on the funds when they are withdrawn, and with some savvy planning, that moment should be at a lower tax bracket than you find yourself today.
Let’s take a look at Fortis Inc. (TSX: FTS)(NYSE: FTS) and Royal Bank of Canada (TSX: RY)(NYSE: RY) to see why they might be interesting picks.
Fortis
Fortis owns natural gas distribution, power generation, and electric transmission assets in Canada, the United States, and the Caribbean.
Big acquisitions south of the border in recent years are performing well, and Fortis now has a majority of its assets located in the United States.
The company’s revenue primarily comes from regulated businesses, which means cash flow should be predictable and reliable. In addition, Fortis has $14.5 billion in capital programs on tap for the next five years. This should boost the rate base enough to help support targeted dividend growth of 6% per year through 2022.
The company has raised the distribution every year for more than four decades, so investors should feel comfortable with the guidance.
At the time of writing, the stock provides a yield of 4%.
A $10,000 investment in Fortis 20 years ago would be worth more than $75,000 today with the dividends reinvested.
Royal Bank
Royal Bank reported nearly $11.5 billion in net income for fiscal 2017. That’s almost $1 billion in profits per month!
The company has strong personal and commercial banking, wealth management, capital markets, and insurance businesses that combine to provide a robust and balanced revenue stream.
Some investors are concerned rising interest rates could cause a pullback in the Canadian housing market and hit the banks. A total meltdown would certainly be negative, but most analysts predict a gradual decline, and Royal Bank’s mortgage portfolio is capable of riding out a downturn.
Overall, higher interest rates tend to be a net benefit for the banks.
Royal Bank has a strong track record of dividend growth, and that should continue. The current payout provides a yield of 3.6%.
A $10,000 investment in Royal Bank 20 years ago would be worth more than $95,000 today with the dividends reinvested.
The bottom line
There is no guarantee these two stocks will deliver the same returns over the next two decades, but the strategy of buying quality dividend stocks and reinvesting the distributions in new shares is a proven one for RRSP investors.
