Financial advisors will always emphasize the importance of creating multiple income streams. The COVID-19 pandemic showed us the fickle nature of the economy, as unemployment rates touched multi-year highs in just a few months. But creating a passive-income stream also requires a significant amount of capital.
For example, if you are looking to buy a condo and rent it out in any major Canadian city, you will need to deploy at least $500,000. If you receive $20,000 in annual rental income, it suggests a return of just 4%, and this is before accounting for expenses such as monthly maintenance or taxes. As a landlord, you will also need to be ready for periods of vacancies, driving down the effective yield by a significant margin.
Additionally, as interest rates are near record lows, it might not make financial sense to invest in this asset class if you are looking to beat inflation rates consistently. But income-seeking investors can buy and hold dividend stocks such as Enbridge (TSX:ENB)(NYSE:ENB) in their TFSA to build a tax-free stream of passive and recurring income.
The cumulative TFSA contribution room is $75,500
The Tax-Free Savings Account is a registered account that has gained in popularity among Canadians. The TFSA was introduced back in 2009, and the maximum cumulative contribution room stands at $75,500. Further, any withdrawals from this account in the form of capital gains, interest payments, or even dividends are exempt from Canada Revenue Agency taxes.
The TFSA is an ideal account to hold quality dividend-paying stocks, where you can benefit from tax-free dividend payouts as well as long-term capital gains.
But investing in dividend-paying companies also carries certain risks. You’ll need to identify companies that generate predictable cash flows, a tasty dividend yield, and the ability to get through economic downturns by maintaining payouts across business cycles.
Enbridge, for example, is a diversified energy infrastructure company, and its cash flows are backed by long-term contracts. So, Enbridge is relatively immune to commodity prices. Further, the energy heavyweight has a wide base of cash-generating assets that have allowed the company to increase dividends at an annual rate of 10% in the last 26 years.
At the time of writing, ENB stock pays investors annual dividends of $3.34 per share, indicating a forward yield of 6.34%. So, an investment of $75,500 in ENB stock will allow the investor to generate $4,786 in annual dividends, which results in a daily payout of $13.10.
Enbridge has a sustainable payout ratio
A key metric that dividend investors should look for is a company’s payout ratio. Enbridge will continue to invest heavily in expansion projects, which, in turn, will allow the company to increase cash flows and earnings in the future. Enbridge expects cash flows to increase distributable cash flows between 5% and 7% through 2023, which indicates further dividend gains can be expected.
Enbridge also aims to maintain a payout ratio of less than 70% and reinvest excess cash flows in capital expenditures or lower its debt profile.
Enbridge is just one example of a quality dividend-paying company. It does not make financial sense to invest $75,500 in a single stock. Investors should instead identify similar companies to create a robust portfolio of dividend-paying stocks.