dividend tax credit

The term “buying on margin” means that you’re borrowing money from your broker to buy securities. The main cost involved with this stock market trading strategy is interest on the money you borrow. Plus, when you sell a security that you’ve bought on margin, you must first pay back the loan from your broker.

How to build a winning stock market trading strategy using margin

If you could buy on margin when the market hits bottom, stay margined as the market rises, and sell out at the peak, you could very quickly build a large fortune. But of course, no one has the sense of superhuman timing necessary to consistently succeed in that.

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Investors continue to look for ways to profit from rising commodity prices. Some are considering a unique kind of tax shelter: flow-through funds. Flow-through funds mainly invest in flow-through shares issued by junior mining and oil companies. The companies spend the money they receive for these shares on mineral exploration and development, which carries certain tax benefits, in the form of tax credits and tax deferral. These tax benefits “flow through” to investors in the fund. To take advantage of them, investors need to hang on to the funds for a fixed time, usually 18 months to two years. At the end of that period, flow-through funds convert into standard mutual funds. These tax shelters developed out of a Canadian government plan to encourage natural resource exploration and development....

The dividend yield of the S&P/TSX Composite Index is now around 3%, up from 1% in the early part of this decade. This rise is partly because more companies are using their excess cash for dividends instead of buying back shares. This new focus on dividends is a good thing for investors. Dividends can contribute up to a third of an investor’s long-term returns, without even considering the effects of the dividend tax credit. As well, dividends are more dependable than capital gains as a source of investment income. Moreover, growing dividends help shield you from inflation. The recession has forced many companies to cut their dividends in order to conserve cash. The response is usually a big drop in the stock price....

Many investors consider annuities when they are planning their retirement investing. There are basically three types of annuities: Term-certain annuities are payable to you, or your estate, for a fixed number of years. Your estate will receive the payments even if you die. You could outlive this type of annuity....

One of the most concrete things about an investment is its dividend yield — the percentage you get when you divide its current yearly dividend payment by its price. It’s an indicator we pay especially close attention to when we select stocks to recommend in our Canadian Wealth Advisor newsletter. But yield, high yield especially, can give you a false sense of security. Investors in high dividend stocks have a natural tendency to think that all investment income is nearly as safe and predictable as bank interest. In fact, investment income can dry up in a heartbeat. Companies are sometimes unable to honour their commitments, and they sometimes spring the bad news on you with no warning. Rather than a sign of a bargain, high yield may be a danger sign. It may mean insiders are selling and pushing the price down. A falling price makes yield go up (because you use the latest dividend to calculate yield). When an investment does cut or halt its dividend, its yield collapses....

Right now, Canadian income trusts pay out a high percentage of their cash flows to their unitholders. This lets them avoid paying corporate taxes. It also gives many of them significantly higher yields than a lot of dividend-paying common stocks.

Canadian income trusts face tax changes in 2011

In 2011, the Canadian government will begin taxing income trusts (with the exception of real estate investment trusts or REITs)....

Long-time Successful Investor readers may recall that a decade or two ago, we regularly reminded them that dividends could contribute up to a third of their long-term investment returns, without even considering the tax-cutting effects of the dividend tax credit (see below). Earlier in this decade, yields of dividend paying stocks were generally too low to provide a third of investment returns. But now that yields of dividend paying stocks have moved back up to their current level, it’s realistic to assume they will once again contribute as much as a third of your total return. That’s a good thing for investors, since dividends are more dependable than capital gains as a source of investment income.

Tax credits add to your gains

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If you could buy on margin when the market hits bottom, stay margined as the market rises, and sell out at the peak, you could very quickly acquire a measurable proportion of all the money in the world. Nobody ever succeeds in that, of course. This gives you an indication of the difficulty of spotting and profiting from market tops and bottoms, with or without the use of margin. My view is that if you are going to use margin borrowing to invest, it’s all the more important to follow our three key investing rules: invest mainly in well-established companies; spread your money out across the five main economic sectors; and avoid stocks that are in the broker/media limelight. If you religiously follow that advice and expand your portfolio using margin, you are going to make money over long periods — and you will gain tax benefits. You’ll be able to write off your margin interest in full against ordinary income in the current year. However, you’ll pay less than ordinary income-tax rates on dividends from Canadian stocks, thanks to the dividend tax credit. More important, you’ll defer all capital gains taxes until you sell, and only pay taxes on capital gains at half the rate you pay on ordinary income....

With bonds yielding just 2% to 3%, we believe that income-seeking investors are better off sticking with high-quality utility stocks, such as these four electricity generators. All have consistently posted strong earnings, and have long histories of raising their dividends. Unlike bond-interest payments, which are taxed as regular income, their dividends qualify for the dividend tax credit. They also have greater capital-gains potential. TRANSALTA CORP. $20 (Toronto symbol TA; Conservative Growth Portfolio, Utilities sector; Shares outstanding: 197.8 million; Market cap: $4 billion; Price-to-sales ratio: 1.3; SI Rating: Average) operates over 50 electrical-power plants in Canada, the United States and Australia. TransAlta uses coal to generate 60% of its electricity, and owns three coal mines (two in Alberta and one in Washington State). This helps keep its costs down. Natural gas fuels 30% of the company’s electricity production, and hydroelectric and other sources account for 10%....

As a general rule, it’s better to borrow to buy stocks after a drop, rather than when the market has steadily risen for several years. We think you’ll benefit most from this buying opportunity by sticking with the kind of stocks we recommend, as well as the mutual funds and ETFs we recommend in Canadian Wealth Advisor.

These include the iUnits Dividend Index Fund $15.50, symbol XDV on Toronto, (Shares outstanding: 21.4 million; Market cap: $332.5 million), which holds the 30 highest-yielding Canadian stocks. These stocks are included in the index based on their proportionate dividend-per-share weight. The weight of any one stock is limited to 10% of the fund’s assets. iUnits’ MER is 0.50%, and it has a dividend yield of 4.7%.

Dividend-paying stocks or funds that invest in high-quality, dividend-paying stocks will give you regular dividend income and cash flow to pay the interest on your investment loan. They’ll also benefit most from a stock market rebound.

Today, you can borrow for as little as 3.25% if you use your home as collateral. Over long periods, the total return on well-diversified, high-quality stocks and mutual funds runs between 10% and 11%. So, in addition to the tax advantages, you can expect to earn more than your borrowing cost.

But borrowing to invest is not without risks, including the risk of increasing your leverage. The amount you owe on your investment loan will stay the same, regardless of what the market does, but every dollar your portfolio gains or loses will come out of your equity. In addition, if you take out a variable rate loan, the interest rate you pay could eventually rise about the return on the fund.

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