Canadian savers are using their self-directed Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs) to build portfolios of investments that can provide retirement income to go along with company and government pensions.
One popular investing strategy for building wealth involves owning top TSX dividend stocks and using the distributions to buy new shares. The same idea can be applied to Guaranteed Investment Certificates (GICs) that currently offer attractive rates.
Power of compounding interest and dividends
Investors who buy multi-year GICs can usually opt to have the interest compounded. That drives up the total return on the investment. For example, a five-year $10,000 GIC offering 5% pays $500 per year. If you take the interest each year, the total return is $2,500 at the end of the term. However, if you reinvest the interest each year, the total return ends up being $2,762.82. That’s 10.5% more money earned.
Reinvesting dividends follows the same idea. The dividends are used to acquire new shares. The next dividend payment is larger due to the higher share count. This, in turn, buys additional shares that generate even more dividends on the following distribution. The process takes advantage of pullbacks in the share price as the distributions can buy a larger chunk of new shares. Top dividend stocks typically raise their distributions on a regular basis, and the share prices tend to drift higher over the long run. The combination of reinvesting dividends, distribution growth, and share-price growth can have a profound impact on wealth over the course of two or three decades.
In the current environment, many top TSX dividend stocks now trade at discounted prices.
Fortis
Fortis (TSX:FTS) trades near $53.50 at the time of writing compared to a high of around $65 last year.
The company recently reported second-quarter (Q2) 2023 earnings that topped Q2 2022 results. Adjusted net earnings came in at $302 million compared to $272 million in the same period last year.
Fortis has increased the dividend for 49 consecutive years and expects to raise the payout by 4-6% per year through 2027. Investors who buy the dip can get a 4.2% dividend yield today.
Fortis has a dividend-reinvestment plan (DRIP) that offers a 2% discount on shares purchased using the dividends.
Telus
Telus (TSX:T) has increased its dividend annually for more than two decades. Investors normally see a 7-10% increase per year.
Telus stock trades near $23 per share at the time of writing compared to more than $34 at the peak in 2022. The drop looks overdone, given the solid outlook for revenue growth this year.
Rising interest rates and weak results at the Telus International subsidiary are to blame for the slide in the share price, but the core business that provides mobile and internet services remains in good shape.
Investors who buy Telus at the current level can get a 6.3% dividend yield.
Bank of Nova Scotia
Bank of Nova Scotia (TSX:BNS) raised its dividend by nearly 3% when the bank released fiscal Q2 2023 results. That suggests the board is comfortable with the revenue and profits outlook.
BNS stock is a contrarian pick. The bank has underperformed its peers in recent years, but a new chief executive officer took over in 2023 with plans to drive better returns for shareholders. A strategic review of the business is underway, and big changes could be announced by the end of the year. Monetization of some of the international operations could be on the table. Bank of Nova Scotia has businesses in Mexico, Peru, Chile, and Colombia. The Mexican operations will probably remain part of the mix, but the others could get sold with the funds used to invest in other growth opportunities.
In the meantime, investors can buy BNS stock at a cheap price near $64 and get a 6.6% dividend yield. The stock traded above $90 in early 2022, so there is decent upside potential on a rebound.
The bottom line
TFSA and RRSP investors can get great rates and yields on GICs and top dividend stocks in the current market conditions. Harnessing the power of compounding by reinvesting interest and dividends requires patience and resolve, but it can help you build wealth over the long run.
