Dividends: An Oldie but a Goody
If March taught us anything, it's that it often pays to be a courageous investor. The stock market suffered last month through one of its rockiest stretches in years. But despite the heightened volatility that began in late February, blue-chip stocks actually finished March in positive territory.
Still, there was a way for savvy investors to have remained fully invested in the market while simultaneously enjoying a much smoother ride. It's called dividend investing.
Last month, for example, the dividends paid out by stocks in the Dow Jones Select Dividend Index offered investors some ballast amid the market storm. What's more, the Dow Jones dividend index returned 1.1 percent in March, which was slightly better than the 0.7 percent gain for the Dow Jones industrial average.
Investing in dividend-paying stocks is one of the oldest strategies on Wall Street. But in recent years, it has gotten short shrift. Investors have sought to get rich more quickly through more aggressive types of equities that don't typically return to shareholders a portion of the underlying company's earnings in the form of dividends.
To be sure, dividends made headlines earlier this decade when the Bush administration and Republican-controlled Congress lowered the maximum tax rate on qualified dividend income to just 15 percent. But even so, dividend-paying stocks haven't been fully embraced by the market. In recent years, fast-growing emerging-markets and foreign stocks have garnered far more attention than dividend-paying U.S. equities.
Still, over long periods, the slow-and-steady path offered by dividend-paying stocks has proved to be the ultimate winning bet. Since 1972, dividend-paying stocks in general have returned 10.3 percent a year, according to a recent analysis by the investment management firm Eaton Vance. By comparison, stocks that don't pay out any dividends have averaged just 2.4 percent annual gains during this stretch.
Dividend investing is particularly useful in limiting your losses during bad stretches in the market. Last year, for example, when stocks sold off on economic worries between the start of May and the end of August, dividend-paying stocks in the Standard & Poor's 500 index fell 0.5 percent. Yet during this same period, those stocks in the S&P 500 that don't pay out any dividends tumbled 5.3 percent. "That was 10 times the loss for the nondividend payers," says Howard Silverblatt, senior index analyst for Standard & Poor's.
But that's to be expected. Silverblatt notes that during big bull market runs, dividend-paying stocks usually get trounced by the stocks that don't pay dividends, as investor interest turns to growth. "But when times are bad, dividend-paying stocks don't go down as much," he says.
Silverblatt adds that over the past 12 months through the end of March, dividend-paying stocks in the S&P 500 have been trouncing those that don't pay dividends by 13.6 percent vs. 7.1 percent.
So how should investors treat dividends?
For starters, don't overlook them. While it's true that corporations are paying less than a third of their earnings back to their shareholders in the form of dividends–compared with more than 50 percent in the 1960s and 90 percent in the 1930s–dividends still matter. If you don't believe that, consider this: Since 1926, stocks in general have delivered average annual total returns (that's price gains plus dividend income) of 10.4 percent. That compares favorably with the 5.9 percent average gains for bonds during this same stretch. But if you were to strip out the dividend yield, stocks would have returned only 4.3 percent annually, according to Eaton Vance. In other words, without dividends, stocks trail bonds and barely beat the returns of cash.
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