Why it Pays to Invest in Dividend Stocks Over the Long Term
Dividend-paying stocks have a sizeable fanbase among seasoned investors. Companies that offer dividends tend to be established, consistent, and in possession of a steady cash flow, making them low-risk, low-volatility investment options. Where smaller, more volatile companies can placate shareholders with higher returns, larger companies often use dividend payouts to entice new investors and hold their existing ones.
These low-risk options may not work for every investment approach, but dividend-producing stocks can offer great benefits under the right circumstances – especially for portfolios built for the long-term. Beyond the ability to rely on these semi-regular payouts as an income stream – a strategy favored by retirees – dividends are an excellent vehicle for compounding earnings through reinvestment. While it may mean eschewing the instant gratification of immediate returns, reinvestment done properly can compound earnings far beyond the dividend payments on their own.
A Charles Schwab study of two hypothetical portfolios using returns data from S&P 500 Index and S&P 500 Total Return Index from January 4, 1988 through August 29, 2017 – each with an initial investment of $10,000, but one reinvesting all dividends and another reinvesting no dividends – neatly illustrates this point. The “hypothetical S&P 500 Index fund in 1988 would have swelled to more than $180,000 by mid-2017 had dividends been reinvested,” but taken on their own, the dividends would only have totaled $95,000.
While dividends are valuable without reinvestment, it is important they outpace or match the rate of inflation in order to maintain their purchasing power. Schwab notes the S&P 500 has managed to do this since 2012, providing ideal performance over that time span. The S&P 500 provides additional value to investors because “of the 500 large-cap stocks tracked by the S&P 500, more than four-fifths pay dividends,” making it an ideal place to both gauge performance and easily locate dividend-paying stocks.
Another option for reinvesting dividends is through a DRIP, or dividend reinvestment plan. These plans dispense with quarterly checks and instead automatically reallocates dividend earnings to purchase new shares for the investor. Most are company-run, which means commission-free purchasing power and, in some instances, the opportunity to buy shares at a discount determined by the company. While investors are responsible for taxes on the dividends – dividends that never manifest themselves as cash – DRIPs offer a win-win, giving companies the opportunity to generate equity capital while investors enjoy the benefit of convenience.
The power of compounding makes dividend stocks an attractive option for investors. While dividend stocks may not carry the allure of massive short-term returns, their ability to generate multiplying value over time means they should be a consideration for any investor’s portfolio – a slow-and-steady-wins-the-race choice that long-term investors love.
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