Since 1930, dividends account for 40% of stock market returns and 54% during decades with elevated inflation.
Dividend /ˈdivəˌdend/ noun: a sum of money regularly paid by a company to its shareholders out of its profits
If you think dividend investing is just for boomers, think again
Novice investors tend to be drawn to flashy investments like tech stocks and crypto.
The ones in the news with groundbreaking artificial intelligence. The tokens promising the next Bitcoin-eque moonshot. The ones with the loudest CEOs.
But what few new investors realize is that many of those companies aren’t profitable yet. And unprofitable businesses don’t pay dividends.
You know who does know that?
Warren Buffet. Your parents and grandparents. And virtually every investor over the age of 65 who’s set themselves up for a financially secure retirement.
The Gift That Keeps on Giving
We seldom say the word literally. It’s been misused ad nauseam. But today, we’ll make an exception:
Stocks with dividends literally pay you to own them.
And the reason they need to be a mainstay in every investor’s portfolio — whether you’re just getting started or have been trading for decades — is because of compound interest.
It’s what’s behind the popularity of high-yield savings accounts, and the reason why so many people get themselves into dangerous credit card debt.
Compound interest is the interest on both the initial principal and the accumulated interest from previous periods, which makes the total amount of your investment (or in the case of credit cards, your debt) grow faster.
This is why investing in dividend-paying stocks — and importantly, holding them long term — results in market-beating returns. Going back to 1960, 84% of the total return of the S&P 500 is attributed to reinvested dividends.
And over the past 40 years, stocks that increased or initiated dividends produced an average annual return of 13.74% vs. a 9.6% for their non-dividend-paying counterparts:
The DRIP Trick
A lot of that has to do with dividend reinvestment plans — or DRIPs — the secret sauce behind the compounding effect of dividend-paying stocks.
When you receive a quarterly, annual or special dividend payment from a stock you own, DON’T TOUCH IT!
Symbiotic relationship: By reinvesting those funds into additional shares of the company, it enables you to steadily increase your wealth (via compounding interest) as the company’s able to further grow its market cap.
It’s a mutually beneficial relationship. Like corals and algae. Wes Anderson and Bill Murray. Or you and your dog.
Set it and forget it: Most online brokerages allow you to automate your DRIP selections for any or all positions in your portfolio with just a few clicks.
From there, they take care of it so every time you receive a dividend payment, it’s automatically used to acquire more shares.
Dividend Royalty
Companies with proven track records of paying dividends — and particularly those that raise those payments annually — often belong to sectors that perform well in any market or economic climate.
Recession-resistant sectors like:
- Consumer staples (e.g., food for your family).
- Energy (e.g., gas for your car).
- Healthcare (e.g., medicine for your kids).
- And utilities (e.g., keeping the lights on at home).
Think needs, not wants. The things people will always pay for no matter how tight household budgets get.
So it’s no surprise that companies with a history paying dividends and increasing their yields are (1) established industry leaders in inelastic sectors, (2) highly profitable and (3) often household names.
And because of that profitability, many of them have been able to increase their dividends for so long, they now belong to exclusive clubs.
1. Dividend Aristocrats are companies that have raised their dividend payouts for at least 25 consecutive years.
2. Dividend Kings have increased their dividends for at least 50 consecutive years.
TL;DR
New investors shouldn’t approach the market like a get-rich-quick scheme. That’s what scratch-off lotto tickets and multilevel marketing are for.
Slow and steady still wins the race and compound interest is the vehicle that gets you across the finish line.
In next week’s issue of The Big Idea, we’ll survey some stocks paying big dividends in resilient market sectors that are insulated (or benefit) from inflation.