Introduction

Any purchase of shares brings with it the privilege of receiving dividends (even in the case of shares that do not currently pay a dividend, you have at least the prospect of receiving any future dividends if, as and when the issuer adopts a dividend-paying policy). But not all share purchases constitute dividend investing. Dividend investing has acquired a narrower meaning. For us, what distinguishes it from regular equity investing is the fact of adopting, as a decisive factor in an investor’s choice of which stocks to buy, the current level (and expected future level) of their dividends.

Before we start, here are five points of clarification:

• One, we will not re-discuss the validity of dividend-investing as an investment approach, a subject that we discuss widely in the three previous commentaries in this series: Dividend investing: is it closet stock picking? , Six advantages of dividend investing: a critical assessment , and Dividend investing: everything you wanted to know about it (or almost ). In this commentary, we look instead at the mechanics available to fans of dividend investing.
• Second, by tradition, dividend investing is understood to exclude the purchase of preferred shares that are considered more similar to securities like bonds, to wit the more general term fixed income securities which includes both. 
• Three, in theory (we discuss this at length in our previous commentaries) one might think that investors are followers of dividend investing because they are aiming for a better total return (dividends + capital gains), but in practice we believe that it is the current cash dividend yield which is the main attraction. We are writing this commentary on that basis. 
• Four, this review focuses on dividend investing primarily using Canadian market data. Two reminders: i) the Canadian stock market is not sufficiently diversified, and investors should also invest outside Canada (see Geographic diversification on our site); and ii) we believe that the conclusions we draw from this commentary apply to dividend investing outside Canada, but that demonstration remains to be done. We do identify a couple of large, low-cost US-listed dividend-focused ETF’s for readers interested in US dividend investing (remember that Canadians cannot buy US-based  mutual funds).
• Five, generally, it is preferable from a tax perspective for Canadians to hold Canadian stocks that pay a dividend outside a registered account (i.e. outside a RRSP / TFSA), and hold foreign shares paying a dividend in a registered account. One nuance: for U.S. stocks, holding them in a RRSP is generally preferable to a TFSA because of the different treatment of U.S. withholding tax under the Canada-US tax treaty.

Withholding taxes will be deducted from foreign dividends received in a TFSA, and these fees are not recoverable. The Canada-United States Tax Convention (Treaty) provides for U.S. dividends and interest to be received free of tax when earned by a trust Which is generally exempt from income tax in Canada, and Which is operated exclusively to administer or Provide pension, retirement, or employee benefits. S. 146.2 of the Income Tax Act states that a TFSA is not Deemed to be a retirement savings plan. Source: TaxTips . In general, see Taxation and Investing , Registered (RRSP) Accounts , and TFSA’s: a new tax-advantaged account on our site.

Now let’s look at how to practice dividend investing, distinguishing by your objective: are you looking for a current cash income stream? Throughout this analysis, there is a common thread:  are any of these methods superior to a classical index approach i.e. buying the entire market by investing in a low cost index exchange-traded fund?

An investor seeking current cash income

For fans of dividend investing looking for current cash income in cash, here are their options:

• Buying and holding shares directly, and receiving the cash dividends
• Investing in a mutual fund specializing in dividend investing; or 
• Investing in a exchange-traded fund that specializes in dividend investing.

Let's look at each in turn.

Buy and hold directly

Here, the investor buys the shares and holds them in a broker's account. The dividends are credited to their account and are available for current consumption or other purposes.

The consequences?

• If an account is with a discount broker there are no management or other fees so you receive in full the dividends paid by the issuers. What kind of yields are we talking about? The TSX market overall is currently yielding of about 2.7%, and the U.S. S & P 500 1.95%. An investor who practices dividend investing obviously hopes to exceed those figures. In our prior commentary Dividend investing: is it closet stock picking? we give some statistics on the distribution of dividend yields.

Because of the poor breadth in the Canadian market, direct stock ownership is an attractive alternative for some investors. It allows better control of taxable events, and has no ongoing management expense ratio if the stocks are appropriately selected. Shakesprimer

• You have a complete tax flexibility, because you can sell individual securities in your portfolio that have declined in value and realize a tax loss when it suits you, for example in the same year in which you realize a taxable capital gain on the sale of other assets.
• For a large portfolio, it is difficult and laborious to establish a diversified portfolio with this method. And for a portfolio of smaller size, it is almost impossible.
• For the holder of a medium size portfolio, the amount invested in each share is likely to be modest if you establish a healthy diversification. We believe it is almost essential to use a discount broker; otherwise your commission expenses are likely to be excessive. 
• There is complete management flexibility. You can select shares at will, using your own criteria or by tracking popular model portfolios such as the Dogs of the Dow or the Dividend Aristocrats, and reorganize your portfolio to track changes in those model portfolios or even make outright changes in your approach if desired. 
• This method requires time and knowledge to build a portfolio, unless you blindly follow popular portfolios. 
• This method allows you to manage the number of transactions in your portfolio, and to minimize transaction costs and taxable capital gains.
  
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