Dividends as a Growth Strategy
Dividends can be a source of current income for retirees and others who want an income stream without selling their underlying investments. For long-term investors, reinvested dividends can be a powerful growth engine. A 2013 study by Standard & Poor’s found that dividend income represented 34% of the monthly total return of the S&P 500 index from 1927 through 2012.1 (Total return includes capital gains, dividends, interest, and distributions.)
In the strong growth environment of 2013 and 2014, when rising stock prices took center stage, dividends played a smaller role in total returns: 8.60% and 16.78%, respectively. By contrast, in 2011, when the S&P 500 was flat, dividends represented 100% of the 2.11% total return.2
Good Things in Small Packages
Annual dividend payments are typically a small percentage of a given stock’s value; among companies in the S&P 500 index that paid dividends, the average dividend yield was 2.3% in 2014.3 The key to a dividend strategy is that this small percentage increases returns in good years and helps mitigate losses when the market turns downward. The S&P study found that the dividend component of the S&P 500 index total return has been far more stable than price changes.4 And when reinvested dividends are compounded over time, the effect can be dramatic (see graph).
Although stocks that pay regular dividends may help boost total returns, all investing involves risk, including the potential loss of principal, and there is no guarantee that any investment strategy will be successful. Investing in dividends is a long-term commitment. Investors should be prepared for periods when dividend payers drag down, not boost, an equity portfolio. A company’s dividend can fluctuate with earnings, which are influenced by economic, market, and political events. Dividends are typically not guaranteed and could be changed or eliminated.