Invest for dividends
The changes that are being made to the dividend tax credit could mean big gains in after-tax returns for investors.
The proposals were contained in Finance Minister Jim Flaherty’s spring budget and are still working their way through Parliament but as far as the Canada Revenue Agency is concerned they became effective last Jan. 1. So even though they aren’t technically law at this stage, you can take advantage of them – and you should!
The question is how? Of course, you can invest in common stocks with high dividend yields. But many people prefer to mutual funds because they require less money and offer immediate diversification. Here are two that I like a lot. Ask a financial advisor if they are appropriate for you.
GGOF Monthly Dividend Fund. This fund has been on the Recommended List of my Mutual Funds Update newsletter since October 2003 but for much of that time readers couldn’t buy units because it was capped in early 2004. Fortunately, it is now open again for business and if you are looking for income in a non-registered portfolio this is a good place to start.
The fund’s mandate is to hod 50 per cent of its assets in preferred shares. It was just a tick below that as of Aug. 31, with 48.2 per cent of the assets in preferreds. The rest of the money is invested in income trusts (37.8 per cent), common stocks (4.9 per cent), and cash (9.1 per cent). The quality of the preferred shares is first rate, with issues from such blue-chip companies as Manulife Financial, Brookfield Properties, Great-West Life, BCE, Power Corporation, and Fortis. The income trust component is also impressive with organizations such as Yellow Pages, RioCan, and Canadian Oil Sands Trust in the top 20 holdings.
The fund’s total return is not impressive (4.8 per cent in the year to Aug. 31) but it pays a monthly distribution of 3.5c per unit, all of which is eligible for the dividend tax credit. The lead manager is the veteran John Priestman, backed up by the very capable team of Kevin Hall and Michele Robitalle. I highly recommend this fund for investors who are looking for dividend income in a non-registered portfolio. Don’t buy it if your priority is capital gains.
Note that there are both Classic and Mutual Fund units on offer. For maximum yield, choose the Mutual Fund units which have a lower MER.
Signature Dividend Fund. This entry from the CI organization is one of the few funds in the Canadian Dividend category that has a significant preferred share component, although at 37.8 per cent (as of Aug. 31) it is not as heavily weighted in the sector as the GGOF Monthly Dividend Fund. Moreover, the current weighting could shrink because unitholders recently approved a mandate change that allows more of the portfolio to be invested in common stocks. For those reasons, this fund would be a second choice to the GGOF entry on a cash flow and tax efficiency basis.
That said, it’s a very respectable fund and it offers good exposure to the dividend tax credit. The fund pays monthly distributions of 4c per unit, most of which is treated as dividends or capital gains for tax purposes. In 2005, dividends accounted for 25c of the total payment, just over half. So far in 2006, according to Globefund, 20c of the 32c that has been paid qualifies for dividend treatment.
Based on a net asset value of $14.48, the projected 12-month cash yield on this fund is 3.3 per cent, slightly less than that of the GGOF fund. Total return is better than that of GGOF Monthly Dividend. In the year to Aug. 31, the fund gained 9.5 per cent and the three-year average annual compound rate of return was 11.2 per cent. Both figures were below the Canadian Dividend category average but the primary goal here is income, not capital growth.
Overall, this is a good option and should be the number one pick for someone who holds DSC units in another CI fund and wants to make a switch.
Adapted from an article that originally appeared in Mutual Funds Update, a monthly newsletter that provides advice on fund selection and strategies. For subscription information: http://www.buildingwealth.ca/promotion/50plusproducts.htm