Passive income is extremely useful, as it can help individuals and households accelerate their retirement plans and build generational wealth over time. Two low-cost ways to generate a steady and recurring income stream for life are by investing in Guaranteed Investment Certificates (GICs) and quality dividend stocks.
Here, we take a look at both these options to see which is a viable one for passive-income seekers.
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What are GICs?
In the last two years, rising interest rates have made fixed-income instruments such as GICs extremely popular. A GIC lets the investor earn interest on the principal deposited with a bank, credit union, or financial institution.
GICs are similar to a savings account. However, here, your principal amount is locked in for a specific period, which may range from a few months to multiple years. Moreover, a GIC purchased through a bank is protected via the Canadian Deposit Insurance Corporation up to a specific amount.
Several banks offer a 5% interest rate on GICs which is quite attractive, given inflation has cooled off in recent months.
What are dividend stocks?
Publicly listed companies that pay shareholders a dividend are called dividend stocks. Generally, companies allocate a certain portion of their cash flows toward dividends, which means these stocks need to report consistent profits across market cycles. Further, the best dividend stocks increase these payments each year, enhancing the effective yield significantly.
In the last 20 years, several dividend stocks on the TSX have increased their payouts at a significant pace, allowing them to deliver outsized gains in this period. Some of the best dividend stocks in the last two decades include giants such as Enbridge, Canadian National Railway, Royal Bank of Canada, Toronto-Dominion Bank, and Brookfield Renewable.
However, identifying winning bets requires a significant amount of time and expertise, as it’s essential to identify stocks with predictable earnings, sustainable payouts, strong balance sheets, and widening cash flows.
One easy way to invest in dividend stocks is by gaining exposure to exchange-traded funds, or ETFs, such as iShares Core MSCI Canadian Quality Dividend Index (TSX: XDIV).
In the last five years, the XDIV ETF has risen by 28%. After adjusting for dividends, total returns are much higher at 59%. Comparatively, the TSX index has returned 57.6% in this period after adjusting for dividends.
Some of the largest holdings of the XDIV include blue-chip stocks such as Manulife Financial, RBC, and Pembina Pipeline. The current dividend yield of the dividend-paying ETF is close to 4.6%, which is not much lower than GICs. In addition to regular dividend payments, investors can also benefit from capital gains by investing in the ETF.
The Foolish takeaway
Whether you should invest in GICs or dividend stocks depends on factors such as your risk appetite, investment horizon, and age. If you aim to hold the investment for less than five years, GICs might seem a better option and vice versa.
Further, you also need to diversify your portfolio and hold different asset classes to lower overall risk. So, a 30-year-old can allocate 30% towards bonds, such as GICs, and 70% towards equity, such as dividend stocks.
