In my recent post about my investing strategy I mentioned that reinvesting dividends was a big part of my strategy. Many people think of dividend paying stocks as boring, safe stocks that don’t yield much of a return. When in reality this couldn’t be further from the truth.
Sure, compared to a lot of the volatile small-cap companies out there that may double or triple in value in a matter of months dividend stocks will appear slow and boring. Dividend stocks are usually larger, more mature companies that have slower growth and more predictable earnings trends. However, the growth they do provide coupled with steady, growing dividend payouts is a recipe for market crushing returns. Dividends have accounted for over 40% of the S&P500’s total returns over the past 20 years.
To really harness the power of dividends I look for high quality companies that have a long history of increasing their dividend, and I reinvest all the dividends I receive into more shares of the same stock. (Most online brokers will do this for free, typically you just have to enroll your account and you’re all set.) There are multiple benefits to this. First, by reinvesting the dividends received into more shares you’re automatically dollar cost averaging by buying more shares when the stock price falls, and fewer shares when the price is high. As you accumulate shares you start receiving more and more in dividends, working in your favor just like compound interest. My favorite benefit is that each time a company raises its dividend, it accelerates the whole process. It’s like getting a raise for sitting on your hands.
It’s not even complicated to find such great companies that are dedicated to paying, and regularly raising their dividends. The Dividend Aristocrats List is a list of S&P 500 companies that have regularly raised their dividend each of the past 25 years. Some of the companies included are household names such as 3M, McDonald’s, Johnson & Johnson and Wal-Mart. (Disclaimer: I own shares of 3M and J&J) The Dividend Champions list is also an excellent, and bit more inclusive resource for finding quality dividend stocks. Neither of these lists represents a “buy” list, as each stock may or may not be an attractive investment at any given time.
As with any form of investment, dividend investing is not without its risks. Stocks, of any type carry a lot of risk with them. Even the most stable companies can lose you money. As a dividend investor one of the biggest threats to your strategy is that a company will cut, or even stop its dividend payout. This is usually a last resort for CEO’s because they know how negatively investors will react to a dividend cut. If you see that a stock you own has slashed its dividend payment it might be a good idea to dig a little deeper and reevaluate your holding. Look no further than the financial crisis of 2008, and how long companies such as Citi and Bank of America kept their dividend in tact while otherwise hemorrhaging money to see why a cut may be a sign to think about selling.
You’ll notice that I keep mentioning dividend growth. When looking for dividend stocks many people naturally gravitate towards stocks with high yields. After all, earning 6% is better than earning 2%, right?! Well, yes and no. A high dividend yield can be great for a little while, but it can also be cause for concern. Because yield is relative to price per share, a high dividend yield can be sign of a troubled stock that has had its price beaten down by investors fleeing from the company. Whereas a stock with a moderate yield (I prefer >2%) and a long history of dividend growth will actually do better for you long-term. If you keep reinvesting the payouts and the company keeps increasing its dividend each year, it’ only a matter of time before you’re receiving dividend payouts that are larger than your initial investment in the stock!
Regardless of what you’ll hear on CNBC or other media outlets, dividend investing isn’t a “trend” to rush to when the markets are bad, and one to rush out of when things are looking up. You won’t get rich quickly by investing in dividend stocks, but that’s not the point of investing in the first place. As a part of a diversified portfolio, high quality dividend stocks can boost your returns and provide a steady income stream down the road. As always decide how this fits in to your strategy and the amount of risk you’re comfortable with in your portfolio.
If you have any thoughts on investing in dividend stocks feel free to share in the comments below. Happy Investing!