As uncertainty at home and abroad roils the financial markets, income-minded investors seeking protection from the bumpy road ahead may find dividend-paying stocks could offer an attractive mix of features and warrant a place in their equity portfolios.
The appeal is simple: Dividend-paying stocks can potentially provide investors with current income regardless of market conditions.
The potential benefits of dividend-paying stocks
If you own stock in a company that has announced it will be issuing a dividend, or if you are proactively considering adding an allocation to dividend-paying stocks, history has provided evidence of the long-term benefits of dividends and their reinvestment.
A sign of corporate financial health. Dividend payouts are often seen by some investors as a sign of a company's financial health and management's confidence in future cash flow. Dividends can also communicate a positive message to investors who perceive a long-term dividend as a sign of corporate maturity and strength.
A key driver of total return. There are several factors that may contribute to the total return of dividend-paying stocks over the long term. One of them is dividend reinvestment. The longer the period in which dividends are reinvested, the greater the spread between price return and dividend reinvested total return.
Potentially stronger returns, lower volatility. Dividends may help to mitigate portfolio losses when stock prices decline, and from 1990 through 2018, stocks with a history of increasing their dividend each year have also produced higher returns with less risk than non-dividend-paying stocks. For instance, since 1990, the S&P 500 Dividend Aristocrats — those stocks within the S&P 500 that have increased their dividends each year for the past 25 years — produced average annualized returns of 12.13% vs. 9.96% for the S&P 500 overall, with less volatility (13.22% vs. 14.22%, respectively).
If you are considering adding dividend-paying stocks to your investment mix, keep the following thoughts in mind.
Dividend-paying stocks may help diversify an income-generating portfolio. Income-oriented investors may want to diversify potential sources of income within their portfolios. Given current realities present in the bond market, stocks with above-average dividend yields may compare favorably with bonds and may act as a buffer should conditions turn negative within the bond market.
Dividends benefit from potentially favorable tax treatment. Most taxpayers are subject to a top federal tax rate of only 15% on qualified dividends, although certain high-income taxpayers may pay up to 23.8%. However, this is still lower than the current 37% top rate on ordinary income.
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Article initially published on merrilledge.com
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