In these low-yield times, dividend-paying stocks have obvious appeal. Payouts may be as high or higher than bond yields, investors have growth potential, and the tax treatment can be favorable.
Given these advantages, why not go one step further and look for dividend-paying foreign stocks?
“The MSCI EAFE Index now yields over 3%, while the S&P 500 yields just over 2%,” Brian Kazanchy, investment committee chair at RegentAtlantic Capital, a wealth management firm in Morristown, New Jersey, said in an interview. “That’s one indicator there may be significant value in international equities.”
Some traditional sources of U.S. dividends may have lost appeal. “Investors historically have looked to utilities for dividend income,” says Tim McGrath, managing partner at Riverpoint Wealth Management in Chicago, “but some U.S. utilities have been struggling. Foreign stocks seem to be a good place to go for dividends now.”
Foreign stocks have generally yielded 4% to 5%, in this century, and many strong non-U.S. companies have yields higher than those commonly found in the U.S. Australia’s ASX 200 Index recently had an average dividend yield of nearly 5% while other markets such as Singapore, Switzerland, Sweden, and the U.K. also have had relatively rich payouts.
“We recently bought shares of Nestle American Depositary Receipts (ADRs),” says Michael Fein, managing partner at CIC Wealth Management Group in Owings Mills, Maryland. “It’s the kind of company we like, with a durable competitive advantage, and the yield was over 3%.”
Other ideas come from UBS, which just published a list of “global dividend ruler stocks to buy,” via ADRs. Current yields ranged from 2.8% from Teva Pharmaceutical Industries, a leading maker of generic and branded drugs, to 5.5%, for Total S.A., which operates in multiple segments of the energy industry.
Advisors who like the idea of using foreign stocks for yield but who are reluctant to pick individual issues can find many funds in this area, especially ETFs. Popular entries include iShares Dow Jones International Select Dividend Index ETF, with over $2 billion in assets and a 12-month yield of 4.57%, according to Morningstar, as well as SPDR S&P International Dividend ETF, with nearly $1.5 billion in assets and a 12-month yield of 6.08%.
Fein says that some of his clients own individual international equities while others, with smaller portfolios, invest through funds. The two approaches can complement each other. “When we see good companies in a fund, we might buy that fund,” Fein says. “Then we’ll look at that fund’s other holdings, to find other companies we might consider buying.”
Therefore, foreign stocks or funds may offer excellent current cash flow to clients, along with upside potential and portfolio diversification. However, advisors looking into this area should be aware of two tax concerns.
- Tax rates: So-called qualified dividends are taxed at 0%, 15%, and 20% rates. ADR dividends are qualified, and so are dividends from companies based in countries that have certain tax treaties with the U.S. However, foreign stock dividends from companies based in other countries are not qualified, so investors may owe tax on such dividends at rates up to 39.6%. Advisors should be aware of a fund’s holdings to see if non-qualified (highly-taxed) dividend income will pass through to shareholders.
- Withholding: Foreign income tax is often withheld on dividends from foreign stock payouts, including ADRs. If a country’s tax code mandates 15% withholding, for example, a 6% payout would be reduced by 0.9% (15% of 6%), to 5.1%. It is possible to reclaim some or all the foreign tax withheld, but the paperwork might be onerous while taxes withheld from securities held within IRAs may be lost altogether. Advisors should know how much of a foreign dividend a client will actually receive, and the outlook for recovering any withheld taxes.
“We generally keep funds holding foreign dividend-paying stocks in taxable accounts,” says McGrath. That takes advantage of the low tax rate on qualified dividends and permits the possible recovery of taxes paid through foreign withholding.