The Often Overlooked Importance of Dividends

I just finished reading an interesting article from Dreyfus regarding the historical impact of dividends on the stock market’s total return. The paper states that since 1926, dividends have accounted for approximately 50 percent of the stock market’s total return. You can read the paper here.

Stocks paying respectable dividends are often considered to be too conservative for many investors, who prefer to search for potential 10-baggers, or stocks that grow in capital appreciation to ten times their initial value. And yet, having grown up in Atlanta, Georgia, the land of Coca-Cola, I am well-aware of the number of millionaires that Coke stock produced simply by investors simply re-investing their dividends.

Since 2000, an increasing number of companies have chosen to reduce or discontinue their dividends in order to avoid taxation of such dividends. Such companies, with shareholder approval, have decided to plow back such money into the company in hopes of creating internal growth and increased capital appreciation within the stock.

While both approaches have merit, it is important to consider the benefits that dividends can provide. One of the most valuable benefits that dividends provide is protection in down markets, as the dividend ensures a certain level of return. As the paper shows, certain dividend paying stocks, known as “dividend aristocrats,” have actually provided a historically greater rate of return with less risk.

I am a proponent of what is known as core-and-satellite investing. Core-and-satellite investing involves creating a sound, fundamental core for one’s investment portfolio. The core usually consists of a sound, well-diversified equity based component and a sound, well-diversified fixed-income based component. To that core we add one or two investments that are chosen in hopes of providing a little extra return the overall portfolio.

The satellites can be chosen based on various factors, including the current or expected condition of the economy and/or the stock market. Depending on the individual investor’s personal goals and other personal investment parameters, we often recommend an investment that provides both growth and income, including investments focusing on dividend paying stocks.

Stockbrokers and other financial advisers often only recommend investments focused on capital appreciation. Investors should stop and consider whether an allocation to growth and income investments and/or dividend paying stocks is a wise choice to help provide a buffer against downturns in the market.

History has shown that the stock market is cyclical, undergoing both bull and bear markets. As the Chinese philosopher Lao Tzu once said, “the best way to manage anything is to make use of its nature.” Dividends help manage the inevitable downturns in the stock market.

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