This is a guest contribution by Ben Reynolds.  Ben runs Sure Dividend, which uses The 8 Rules of Dividend Investing to help people build a high quality dividend growth portfolio.

Canada’s population is around 36 million.  The United States population is at 321 million.   The United States’ expected GDP in 2016 is $18.56 trillion.  Canada’s is $1.46 trillion. 

Depending on how you look at it, Canada is around 1/10^th the size of the United States.  The Canadian economy is heavily dependent upon natural resources.  The list of largest businesses in Canada is dominated by financial companies and resource based companies.

The United States economy, in contrast, is more diversified.  Health care, technology, and consumer goods businesses are larger.  To put this into perspective, McDonald’s (MCD) has a larger market cap than any Canadian company.

There are many excellent Canadian dividend stocks.  But Canadian investors can better diversify their portfolios by adding exposure to high quality businesses south of the border.

Where Canada Shines

Canada is flush with solid dividend growth investments in the financial and energy sectors.  The country has high quality oligopolistic telecommunication businesses and railroads as well.  Canadian investors are likely better off sticking close to home in these sectors.

Royal Bank of Canada (RY) and Toronto-Dominion Bank (TD) in particular stand out.  Both are high quality banks.  They happen to also be the 2 largest publicly traded businesses in Canada.  I prefer either of these banks to any in the United States for a dividend growth investment.

There are high quality dividend growth stocks in Canada.  But there are few stocks in Canada that match the longevity of the top United States based dividend payers.  Canada also has fewer high quality stocks in the health care and consumer goods sectors to choose from.

Where to Find High Quality Businesses in the United States

The Dividend Aristocrats Index is comprised of 50 businesses with 25+years of rising dividends.  You can see all 50 Dividend Aristocrats here.

The Dividend Aristocrats perfectly complement the type of stocks typically found in a Canadian dividend growth portfolio.  Twenty-five of the 50 stocks in the Dividend Aristocrats Index are in the consumer discretionary, consumer staples, or health care sectors.

Many of these businesses make excellent long-term investments when purchased at fair or better prices.  Companies like Johnson & Johnson (JNJ) and Abbott Laboratories (ABT) have 40+ years of consecutive dividend increases.  They are the ‘best of the best’ in health care.

Dividend growth favorites like Target (TGT), Wal-Mart (WMT), McDonald’s (MCD), and Procter & Gamble (PG) are also Dividend Aristocrats in the consumer discretionary or consumer staples sectors.

What stands out about the Dividend Aristocrats Index is how well it has performed.  The Index has compounded wealth at 10.3% a year over the last decade.  The S&P 500 has generated compound returns of 7.2% a year over the same time period.

The outperformance of high quality dividend growth stocks in the Dividend Aristocrats Index shows that great businesses tend to outperform the market over long periods of time.

Currency Risk (Diversification)

Canadians who invest in United States stocks are subject to currency risk.  If the United States dollar appreciates relative to the Canadian dollar, dollar denominated investments will have a tailwind for Canadians.  Of course, if the United States dollar depreciates versus the Canadian dollar, the reverse is true.

Over the last few years, the Canadian dollar has dropped in value significantly relative to the United States dollar.  The exchange rate was around 1 to 1 at the beginning of 2013.  Right now, 1.3 Canadian dollars equal 1 United States dollar.  This has added about 30 percentage points to Canadian investor returns who invested in United States stocks 3 years ago.

Currency rates fluctuate.  There is no telling if the trend will continue, or if the Canadian dollar will begin to appreciate against the United States dollar.

What is certain is that exposing yourself to uncorrelated risks helps to smooth out returns.  The exchange rate spiked from 1 USD to 1 CAD during the beginning of the Great Recession to 1 USD to 1.3 CAD during the height of the Great Recession.  If this trend continues during the next recession, United Sates stocks could help Canadian investors reduce stock price volatility during recessions.

Taxation

“In this world, nothing can be certain but death and taxes”
- Benjamin Franklin

The United States government may have been founded on the idea of limited government, but the days of a small and efficient government in the United States are long passed.  Like most developed countries, the United States looks to raise tax revenues wherever it can.

And this isn’t good news for Canadians looking to invest in United States equities…

The United States imposes a 15% dividend withholding tax on Canadian residents.  United States dividends are also not eligible for Canadian tax credits.  These facts make investing in United States dividend stocks less preferred for Canadians relative to home country stocks.

But there is a silver lining…

Canadians who invest in United States stocks through registered pension or retirement plans (the alphabet soup of:  RSPs, RIFs, LIRAs, LIFs, and LRIFs) are not subject to the 15% dividend withholding tax.

Therefore, United States stocks can work well in Canadian retirement accounts.  They work less well in taxable accounts due to the fairly onerous 15% dividend withholding tax.

Final Thoughts

There are pros and cons to investing in United States stocks as a Canadian citizen.  On the positive side, the United States offers many of the best dividend growth stocks in the world – especially in the consumer discretionary, consumer goods, and health care sectors.

Currency effects can be viewed either positively or negatively.  They add another level of risk, but also could reduce volatility when paired with Canadian stocks.

Dividend withholding taxes are the biggest negative of Canadians investing in United States dividend stocks.  Canadian investors who utilize retirement accounts can avoid these taxes, but investors with taxable accounts may be better off sticking with Canadian equities due to tax ramifications. 

Don't forget to see our take on why US investors shouldn't overlook Canadian dividend payers. Also, make sure to sign up for blog updates below!