Dividend funds offer stability and growth

Dividend fund did not attract much notice during the booming 1990s, but are now getting a fresh look from investors. They offer the potential for regular income, tax breaks, and capital gains with less risk than many growth-oriented funds.

These funds hold primarily dividend-paying shares of Canadian companies. To a lesser extent, they also invest in bonds and income trusts.

Heavier weightings of well-established companies with solid dividend payout records make today’s dividend funds suitable for both income- and growth-oriented investors.

Tax-advantaged income. Most funds make monthly or quarterly distributions of dividend income generated by the shares in the portfolio. In most cases, the payments qualify for the dividend tax credit, available for dividends received from taxable Canadian corporations.

As a result, distributions from dividend funds are subject to tax than interest income earned from fixed-income investments when the funds are held outside a Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF). Depending on your province and tax bracket, the savings can run anywhere from about 25% to 50% com-pared with interest income.

Dividends add stability. While the blue-chip stocks that dominate dividend funds couldn’t match the spectacular gains that "new economy" stocks posted during the boom, they held up much better during the bust that followed. Part of the reason is that dividend payouts help to cushion these funds when markets tumble. Stocks with strong dividends also benefit when interest rates fall, as they did in the 1990s.

Assess the risk. While many funds have excellent payment records, it’s important to remember that the distributions are not guaranteed. Stock dividends can be cut or suspended — a key consideration as fund managers evaluate companies.

In addition, the prices of dividend-paying stocks can slip if interest rates rise. Finally, their emphasis on common shares means that these funds do fluctuate with the stock market, though much less than funds holding stocks that pay no dividends.

Professional advice can help you determine the role dividend funds might play in your portfolio.