Investing Advice

Time To Take a Look At Dividends

photo: alancleaver_2000

The stock of dividend-paying companies like Philip Morris, Procter & Gamble and McDonald’s might not be as sexy as high-fliers like Apple and Amazon.com — but consistent returns year after year are nothing to ignore.  Traditionally, dividend stocks tend to attract retirees or conservative investors who like the predicability of receiving regular income. But they’re just as suitable for the portfolio of someone who is just getting their start on investing.

Owning dividend stocks is a great idea if there is a chance of a market correction, since the dividend returns can offset losses due to a decline in share price. But dividend stocks are sound investments in any market.  Over longer periods, dividend stocks tend to be among the highest performers in a diversified portfolio. 

“It’s important to remember that stock returns are driven by two key components: dividends and capital appreciation,” says Jason Crowley, financial adviser at Buckhead Investment Partners in Atlanta.  “Since 1926, the S&P 500 has returned approximately 7% annualized when adjusted for inflation.  Reinvested dividends account for roughly two-thirds of that return with the remaining one-third attributable to capital appreciation.”

If you’re skeptical about shifting investment strategies based on the idea that the market might be due a correction, you can rest easy knowing that investing in dividend stocks is a well-established, sound strategy regardless of attempts to time the market.

There are two ways to add dividends to your portfolio:

1. Roll some of your winning non-dividend positions into dividend stocks. If you have secured a large gain in some stocks with the massive rise of the market over the last year, consider moving some of those positions into dividend stocks.  You don’t need to completely unload your Apple stock, but maybe sell some of it, locking in some gains and boosting the dividend return of your portfolio.

2. Invest new money in Dividend Reinvestment Plans. A Dividend Reinvestment Plan, commonly known as a DRIP, is a great and inexpensive way to accumulate shares in a company over time.  Many blue chip companies offer DRIPs and allow you to invest and purchase shares directly from the company.  The result is low fees and automatic reinvestment of your dividends – a great formula for long-term investing.  Many DRIPs allow investors to contribute as little as $50 a month to a certain stock, which is very attractive for new or young investors.

When attempting to identify dividend stocks to invest in, be sure to target companies that are well-established with multiple decades of continuous dividend payouts.  Companies with a track record of increasing their dividend year-after-year might be a place to start.

Amateur investors can benefit greatly from dividend returns.  Cash flow generated from a stock is real money in your pocket.  In order to make money on a non-dividend stock, you must correctly identify a time to sell the stock at a higher price.  Dividends, on the other hand, will earn you money without you having to sell.  

Kevin Duffey blogs about personal finance at 20smoney.com.