Find out how to invest in dividend stocks by following these five simple steps

You can improve your investment safety by focusing on stocks with long histories of dividends. That’s because, among other reasons, dividends are more dependable than capital gains as a source of investment income. Additionally, if you stick with quality dividend stocks, the income you earn can supply a significant percentage of your total return.

These are five of the guidelines we share with investors who want better returns by learning how to invest in dividend stocks.

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How to invest in dividend stocks, step #1: Look for companies and stocks with investment quality

At TSI Network we think investing in dividend stocks is one of the best investment decisions you can make. Dividends serve as a way for companies to share the wealth they accumulate through successfully operating their businesses.

Some good companies reinvest profits instead of paying dividends. But fraudulent and failing companies hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks. For a true measure of stability, focus on companies that have maintained or raised their dividends during economic and stock market downturns. These firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.

How to invest in dividend stocks, step #2: Find companies that have a history of paying dividends

Dividend history is very important to dividend growth stocks. One of the best ways of picking quality high-yield dividend stocks is to look for companies that have been paying dividends for at least 5 to 10 years. As a general rule, companies that make money regularly are safer than chronic or even occasional money losers. Companies can trump up quarterly earnings, or issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce. If you only buy dividend-paying value stock picks, you’ll avoid most frauds.

What is the dividend growths stock’s debt load like? Would it have a hard time recovering from an economic downturn? The more manageable the debt, the better. When bad times hit, debt-heavy companies often go broke first.

How to invest in dividend stocks, step #3: Diversify your dividend-paying, blue chip stock picks

Remember to spread your portfolio out across most if not all of the five main economic sectors: Resources; Manufacturing; Finance; Utilities; and Consumer. That way, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or changes in investor fashion.

By diversifying across the sectors, you also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average. These stocks come along every year. By nature, their appearance is unpredictable; if you could routinely spot them ahead of time, you’d quickly acquire a large proportion of all the money in the world, but nobody ever does that.

How to invest in dividend stocks, step #4: Avoid risky dividend yields

When looking for stocks with high dividend yields, you should avoid the temptation of seeking out stocks with the highest yield—simply because they have above-average yields.

That’s because a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend. Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.

Above all, for a true measure of stability, focus on stocks that have a high dividend yield that they have maintained or raised with their dividends during economic or stock-market downturns. That’s because these firms leave themselves enough room to handle periods of earnings volatility.

How to invest in dividend stocks, step #5: Dividend tax credits can help increase returns for Canadian investors

Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

This means that dividend income will be taxed at a lower rate than the same amount of interest income. Investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income. At the same time, investors in the highest tax bracket pay tax on capital gains at a rate of about 25%.

The Canadian dividend tax credit is actually split between two tax credits. One is a provincial dividend tax credit and the other is a federal dividend tax credit. The provincial tax credit varies depending on where you live in Canada.

Apart from the Canadian dividend tax credit giving you a major tax-deferral opportunity, dividends can supply a big part of your overall long-term portfolio gains.

There is a controversy that says looking only for dividend-paying stocks is misguided and simply a weak form of value investing. What are your feelings about this?

A dividend yield is an alluring feature of a quality investment, but a yield that’s too high can spell trouble. Where do you draw the line between the two?