Canadian investors are using their self-directed Registered Retirement Savings Plan (RRSP) to build portfolios of stocks that can provide retirement income to complement CPP, OAS, and work pensions.
One popular RRSP investing strategy involves buying top TSX dividend stocks and using the distributions to automatically acquire additional shares.
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Power of compounding
Every Canadian learns about the power of compounding the first time they build a snowman. The snowball, as it is rolled, steadily picks up more snow and eventually becomes a giant snow boulder.
The same concept applies to building a retirement fund when a person owns dividend stocks and reinvests the distributions. Each time a dividend is paid and the money is used to buy more shares, the next dividend payment is larger. This, in turn, can be reinvested in more shares.
The impact of the process is small at the beginning and changes as the share price can affect how many new shares are bought with each distribution. Over the long haul, however, the strategy can turn modest initial investments into significant savings, especially when a company regularly raises its dividend and the share price drifts higher.
Enbridge
Enbridge (TSX:ENB) is a major player in the Canadian and U.S. energy infrastructure industries with extensive oil and natural gas pipeline networks that transport roughly a third of the oil produced in the two countries and about a fifth of the natural gas used by Americans. This makes the company’s assets strategically important for the smooth operation of the two economies.
Getting approvals to build large new oil pipelines has become difficult in recent years. As a result, Enbridge shifted its growth investments to focus on exports and utilities, as well as renewable energy. Those decisions have diversified the revenue stream and put Enbridge in a strong position to benefit from rising international and domestic demand for oil and natural gas.
Enbridge continues to grow through acquisitions and development projects. The company says the current $41 billion capital program will help drive 5% annual gains in distributable cash flow over the medium term. This should enable the board to declare steady dividend increases. Enbridge raised its dividend in each of the past 31 years. The current dividend yield is 5.6%.
A $10,000 investment in Enbridge 25 years ago would be worth about $200,000 today with the dividends reinvested.
Fortis (TSX:FTS) is another top Canadian dividend-growth stock that has helped make long-term owners of the shares quite rich.
The utility company owns power generation, natural gas distribution, and electricity transmission networks in Canada, the United States, and the Caribbean. Revenue comes from rate-regulated assets that tend to deliver predictable and reliable cash flow, regardless of the state of the economy.
Fortis is currently working on a $28.8 billon capital program that will raise the rate base by about 7% per year through 2030. The boost to cash flow from the new assets should support planned annual dividend increases of 4% to 6% per year over this timeframe. Fortis increased the dividend in each of the past 52 years.
A $10,000 investment in Fortis 25 years ago would be worth about $185,000 today with the dividends reinvested.
The bottom line
The strategy of owning dividend stocks and reinvesting distributions is a proven one for building wealth. There is no guarantee that Enbridge and Fortis will deliver the same returns over the next quarter century, but these stocks still deserve to be part of a diversified RRSP portfolio focused on generating long-term total returns.
