Income-minded investors seeking protection from volatile market conditions may find that dividend-paying stocks offer an attractive mix of features and warrant a place in their equity portfolios.
The appeal is simple: Dividend-paying stocks can provide investors with tangible returns on a regular basis regardless of market conditions. Investors experienced this first-hand during the Great Recession of 2008 and 2009. While stock share prices fell dramatically during this period, dividends tended to stay relatively stable. Investors (especially retirees) who depended on dividends to pay their expenses welcomed the stability of dividends during this turbulent period.
Note that dividends can be increased, decreased, and/or eliminated at any time without prior notice.
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 provides compelling evidence of the potential long-term benefits of dividends and their reinvestment:
● A sign of corporate financial health. Dividend payouts are often seen as a sign of a company’s financial health and its management’s confidence in future cash flow. Dividends 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 superior 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 (which is based solely on the share price) and dividend reinvested total return.
● Potentially stronger returns, lower volatility. Dividends may help to mitigate portfolio losses when stock prices decline, and over long time horizons, stocks with a history of increasing their dividend each year have also produced higher returns with less risk than non-dividend-paying stocks. Since 1990, the S&P 500 Dividend Aristocrats — those stocks within the S&P 500 that have increased their dividends each year for at least 25 consecutive years — produced annualized returns of 12.1% vs. 9.5% for the S&P 500 overall, with less volatility (13.8% vs. 14.9%, respectively).¹
If you are considering adding dividend-paying stocks to your investment mix, keep the following factors 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 continued favorable tax treatment. Under current tax law, the tax rate for qualified dividends is capped at 15% for most taxpayers. The rate rises to 20% for single taxpayers who earn more than $406,750 in 2014 and for married couples filing a joint tax return who earn more than $457,600.
Note that these rates do not include the 3.8% Medicare surtax on investment income. However, the Medicare surtax is only applicable for higher-income taxpayers (generally, those with incomes over $250,000 if filing jointly or $200,000 if single).
Please note that past dividends are not a guarantee of future dividends. Stock markets are volatile and can decline significantly in response to adverse developments related to the issuer, or by changes in politics, regulations, financial markets, or the economy. Different parts of the market can react differently to these factors. The value of an individual security or particular type of security can be more volatile than, and can perform differently from, the market as a whole. Therefore, companies that offer dividend-paying stocks cannot guarantee that they will always be able to pay or increase their dividend payments.
Your individual tax situation may affect your suitability for dividend strategies. The information in this communication is not intended as tax advice and should not be treated as such. Each individual’s tax circumstance is different. You should contact your CPA or Certified Financial Planner™ to discuss your personal situation.
¹ Source: Standard & Poor’s. For the period Jan. 1, 1990, through Dec. 31, 2013 (earliest data available). Investing in stocks involves risks, including loss of principal. Volatility is measured by standard deviation. Past performance is no guarantee of future results. Indexes are unmanaged, statistical composites, and investors cannot invest directly in any index. The returns shown do not reflect payment of any sales charges or fees an investor would pay to purchase the securities they represent. The imposition of these fees and charges would cause the actual performance to be lower than the performance shown.
The opinions expressed above are solely those of Kondo Wealth Advisors, LLC, (626-449-7783 [email protected]), a Registered Investment Advisor in the state of California. Neither Kondo Wealth Advisors, LLC nor its representatives provide legal, tax or accounting advice.