What Are Dividends?
Simply put, dividends are cash payments made by publicly held companies to investors. They are a way for these companies to give back some of their profits to their shareholders. In 2019, companies listed on the S&P 500 Index paid out $485 billion in dividends.
One reason why dividends are sometimes neglected by investors is because the dividend payment amounts are relatively small. Dividends are usually paid out in pennies per share, such as 40 or 50 cents per share. These, in turn, are divided further into four quarterly payments.
This might not sound like much, but dividends can really add up over time. Also, public companies periodically announce dividend increases but these are usually only a few cents at a time. However, a four cent increase on a 57 cent dividend represents a 7% dividend boost. If a stock’s dividend rose by this much every year, it would double in approximately 10 years.
Comparing Dividend-Paying Stocks to Bond Returns
A recent study conducted by investment advisory firm Capital Investment Advisors looked at the long-term returns of dividend-paying stocks in contrast to bonds over a 40-year period. The study compared a $10,000 investment in the S&P 500, which is a broad stock market index, to the same investment in the Aggregate Bond Index between 1980 and 2020. The study assumed that the investor left the principal intact and took the income produced by the dividends each year.
In 1980, a $10,000 investment in the S&P 500 paid a dividend of 4.21%, or $421, on the initial investment. By 2000, the dividend had risen to $5,724, which represents a 57% annual yield on the original investment.
Over these 40 years, the income from stock dividends grew at about 6% per year while inflation grew at about 3% per year. In other words, dividends grew twice as fast as inflation. In addition, the principal also grew over these 40 years: The initial $10,000 would have grown to $287,000 due to stock price appreciation, or about 8.75% per year. When you add the 3% annual dividend growth, this results in a total annual return of about 11.75%
Now let’s compare this to the performance of bonds over this same period of time. Between 1980 and 2020, the $10,000 invested in the Aggregate Bond Index grew to only $17,893 and paid just $311 per year in interest, or 1.75%. The income from stock dividends easily outpaced the interest paid on bonds over this 40-year period. Annual stock dividend income grew more than 13.5% while bond prices rose less than two times.
Is Hindsight 20-20?
If you’re reading this and thinking you missed the boat, this isn’t necessarily the case. While past performance is no guarantee of future returns, there’s no reason to believe that dividend-paying stocks won’t continue to outperform bonds over the long term going forward.
For example, if you’re relatively young or middle-aged, you’ve probably got decades to go until you retire, which gives you lots of time to potentially benefit from dividend-paying stocks. Even if you’re 50 years of age or over and nearing retirement, you may still want to devote a percentage of your portfolio to growth to improve the chances that your nest egg lasts throughout your retirement.
The key is to think in terms of decades instead of years. Even as stock prices rise and fall, dividends from blue-chip U.S. companies tend to remain steady over the long term. This is true even during times of high market volatility like we’ve experienced this year.
Give us a call if you’d like to talk about the role of dividend-paying stocks in a well-diversified investment portfolio in more detail.
