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.
1–4) S&P Dow Jones Indices, 2013, 2015
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.