While investing in stocks for the long-run is always a prudent idea, stock price gains are not always assured over short term investing horizons because broad market forces control stock dips and rallies. Even the best run companies take a dive when investor sentiment sours!
To address these uncertainties, smart investors know that their stock portfolios must contain blue chip stocks, growth stocks, and so-called "dividend heroes".
Dividend Independence
However, fortunately for investors, individual companies, not market sentiment, control the fate of their own dividend payouts. If a solid company's shares drop on a broad market pullback, it likely will still pay dividends if its earnings are solid.
So dividends are an investor's friend because they provide income that gooses market returns, and a layer of diversification against the broader market.
When markets are rallying, most investors, barring the level-headed and well-advised ones, pooh-pooh dividend stocks and focus solely on growth stock. When markets sour, sobered investors come back to dividend payers.
Moreover, sane investors diversify and have a portion of their assets in bonds or CDs. But what is one to do when 1-year CD rates are no higher than 1.3% and inflation is at its historical average of between 2% and 3%? This is when you should look for strong dividend paying stocks.
Moreover, dividend payers may be less risky than bonds because bonds lose value when interest rates rise but dividend payers may well increase payouts. Plus, you always have the option of selling your shares and shifting into higher yielding bonds when the time is right.
But again, what is one to do if even large-cap US stocks on average deliver a dividend yield of only 2.2% - just about in-line with inflation?
Foreign Dividends
The answer, my friend, is to look abroad for dividends! Because foreign stocks deliver significantly higher dividend yields than their counterparts in the U.S., partly because many foreign companies have a more traditional approach - that their earnings belong to shareholders and must be returned as rising dividend payouts.
Here are a few examples of foreign dividend yields: Israeli grocer, Blue Square Israel 42.68%, Argentine gas utility Transportadora de Gas del Sur 39.72%, CorpBanca of Chile 24%, Brazilian Telecom 10.1%, Finland's Nokia 9.49%, France Telecom 9.4%, and the list goes on... well run companies, national brands, with high transparency and accountability... no fly-by-night operators.
What to know
If you decide to venture into foreign-dividend land, know this:
Irregularity of Dividends: Though foreign dividends are higher, they are less regular in timing and amount. For example, foreign dividend payouts may occur just once or maybe twice a year. Typically, while U.S. dividends are a fixed dollar amount per share, foreign dividends are not a fixed quarterly or annual amount but a percentage of the company's earnings - companies pay out what they can afford to, not what Wall Street expects them to... refreshing, isn't it?! And, typically, foreign companies dish out more over the long haul.
Dividend Taxation: Taxation on foreign dividends is all over the map. Some countries - Argentina, India, Hong Kong, Singapore, the UK and the UAE to name a few - do not tax dividends. Some others do - Switzerland 35%, Australia 30%, Germany 26.4% (the Germans... always down to first decimal precision!), Italy 27%, France 25%, Spain 19%, Brazil 15%, Canada 15%, China 10%, to name a few.
Tax Credits: Thankfully, the U.S. has mutual tax treaties with many foreign countries that U.S. investment houses flock to, to invest in (some lobbyist earned his keep!) This lets U.S. investors receive a credit for taxes paid to foreign governments on dividends. Foreign tax credits can be carried back 1 year and carried forward 10 years. Therefore, you're better off holding foreign dividend payers in a taxable investment account rather than in your tax-free IRA or 401(k). But it goes one step further. Some countries, such as Germany and Canada, only tax dividends held in taxable U.S. investment accounts but waive taxes for dividends paid into IRA and other qualified pension accounts. So speak with your investment advisor or tax preparer to make sure you get this credit. And see if skipping the IRA makes sense if you're going abroad for dividends.
Currency Risk: Foreign companies pay dividends in their local currencies. These dividends are then converted to U.S. Dollars at prevailing exchange rates. Currency exchange rates could fluctuate significantly, either adding to or eroding your dividend yields. So make sure you understand historical currency exchange factors for the countries you are investing in.
Different Accounting Standards: U.S. investors are accustomed to GAAP reporting but many foreign companies follow different accounting standards which may inhibit your understanding of their financials. So tread with caution.
Where to look
ADRs: To get foreign dividends, you don't necessarily have to go too far. Of the 895 foreign companies listed on US exchanges (ADRs), 345 pay dividends. You could easily use one of many online screening tools to build lists of ADR dividend payers and their history of payouts. A good starting point for dividend portfolio selection could be the International Dividend Achievers index which lists foreign companies traded on U.S. exchanges that have consistently increased dividends for at least five consecutive years.
However, ADR companies sooner or later adapt to local dividend levels - and while they may pay slightly higher dividends than American companies, you can get a lot more if you purely invest abroad... that is, in non-U.S. listed firms.
ETFs: You could buy foreign dividend payers in the comfort of your pajamas with a foreign dividend-focused ETF such as the Dow Jones STOXX European Select Dividend Fund which yields 5.9%, the Dow Jones International Select Dividend Index Fund which yields 4.6%, the Wisdom Tree Europe Small Cap Dividend Fund which yields 4.2%, and so on. (These are not specific investment recommendations but merely examples to further your understanding.)
Alternately, you could look up an ETF or mutual fund's listed holdings (this is publicly available information) and cherry pick firms you like if you have the expertise needed to invest in foreign countries. The online world is also rife with blogs and newsletters. Or, you could leverage your own experience if you have spent a reasonable amount of time in some foreign country.
Mutual Funds: There are a number of well managed mutual funds concentrating on the purchase of foreign stocks that pay high dividends. This may be the best idea for those of you that don't have the interest or time to research individual companies or ETFs
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