Guaranteed Investment Certificates (GICs) and dividend stocks are two well-known ways to earn passive income in Canada. Yet, many Canadians may wonder whether one is better than the other.
It really depends on your financial situation, your risk tolerance, and your time horizon. If you are trying to understand which is best, here’s a discussion on whether GICs or dividend stocks are a good bet for your investment portfolio.
GICs are low risk and very safe
Like their name, GICs provide a guaranteed rate of return. That rate of return is generally based on the length of the GIC and interest rates set by the Bank of Canada. Right now, you can find one-year GICs that yield of around 4-5%.
GICs are extremely safe. You provide your capital, and you earn a set rate of interest. Some GICs are cashable, but most are non-redeemable.
Once you purchase a GIC, you are not supposed to sell it. If you sell it, you forfeit any interest that you may be owed. It is important to read the fine print, because sometimes there are even fees to sell a GIC early.
Short-term GICs are the best bet when you are saving for a major purchase (like a vehicle or a car) because they have no downside risk. However, longer-term GIC investments are inflexible and hard to access your capital in the mid-term.
Further, GICs have no potential capital upside. You collect your interest, but you don’t get any opportunity for capital gains. GIC returns are extremely limited.
Dividend stocks are riskier, but there is capital upside to be gained
Dividend stocks are significantly riskier investments. Stocks are volatile and can fluctuate on a whim, especially in the short term. Over the long term, the returns of a stock tend to be based on the performance of its underlying business.
Likewise, no dividend is guaranteed. Companies have no obligation to pay a dividend. That is why investors need to complete significant investment due diligence to ensure that a company’s dividend is reliable and safe.
The best dividend stocks are those that can consistently grow their earnings and cash flows. As a business grows more profitable, it can afford to regularly increase its dividend.
You want to own a business that can pay a dividend but also re-invest in growing its business (so it can grow earnings). That way, you stand a good chance of both capital and dividend income returns.
CNR is an excellent dividend-growth stock
One example of this is Canadian National Railway (TSX:CNR). It has never traded with a huge dividend yield (normally around 2-3%). Despite that, its annual dividend per share is up nearly 15 times over the past two decades.
Likewise, its earnings per share (EPS) has increased by nearly seven times. If you bought this stock at $13.04 per share in 2004 and held it to today, your current dividend yield on cost would be 24%!
Not only that, but your stock value would be up 1,451% in that time. That is a 14.5% compounded annual growth rate in your capital. A $10,000 investment in CNR would be worth $154,988 today.
Your total return would be even more if you reinvested your dividends. CNR stock continues to deliver solid growth in EPS and free cash flows and the outlook remains positive for this business over the decade ahead.
GICs are good, but smart stocks will outperform every time
Had you put that $10,000 in GICs that averaged a 5% interest return per year, your capital would be worth only $26,500. It’s not a bad return, but it hardly compares to that of CNR stock.
The point is that dividend stocks can be extremely successful stocks for total returns. While there is higher risk, it can be worth it to earn a substantially higher reward over longer periods of time.
