So, I should buy companies with the highest dividends, right?

Not so fast. There is something called the “dividend trap” which refers to the act of buying a stock for the high dividend then getting caught when the dividend is cut and the share price drops (dividend cuts and price decreases usually go together).  

All stocks that pay dividends should be carefully evaluated, especially those with very high dividends (over 6%). There is often reason to doubt the sustainability of those payouts.  In fact, historically companies with very high dividends tend to perform worse in the long term than those with moderate to high dividends.

What do you do with the dividends?

Dividends are real money that will be paid into your investment account (RRSP, TFSA, taxable, etc.).  There are three things you can do with them:

  1. Spend them!  Many investors use dividends as a reliable income stream to live on.
  2. Accumulate cash.  Not that we would time the market, but sometimes it’s nice to have some cash ready for when stocks go “on sale”.
  3. Reinvest them!  This is the real magic of dividend investing.  If you don’t need to spend those dividends, reinvesting them in more dividend paying stocks will amplify returns through the wonder of compounding.