Why are they important for your investment strategy?

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When people think of dividends, they think of retirees looking for security and predictable cash payments. Most of the big, exciting tech stocks that make the headlines don’t pay dividends.

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But dividend-paying stocks aren’t just for retirees, and the dividends they pay are far more important to the economy and to your investment strategy than just a quarterly payout. Dividends are the beating heart of the stock market and one of the best predictors of a company’s performance over time.

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What are dividends?

Some companies return part of their profits to their shareholders in the form of periodic cash payments – and more rarely in shares. These payments are called dividends. Companies pay dividends to attract new shareholders and reward existing ones.

Companies that pay dividends are generally older, more established, and have a significant market share. New businesses that are starting up must reinvest every dollar in the business to grow. That said, many of the biggest and most profitable companies in the world – Google, Facebook and Amazon, to name a few – pay no dividends despite having hundreds of billions of dollars. cash. Some investors prefer stocks without dividends because dividends are taxed at the normal rate. They prefer the company to reinvest its profits in the hope that it will grow and the share price will rise.

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Dividends are paid per share. If a stock pays a dividend of 10 cents, you will earn $ 10 on 100 stocks.

Keep in mind these key facts about dividends:

  • With the exception of options, dividends are the only way to profit from owning a stock without selling part of your stake in the company.

  • When interest rates are low, dividends can offer better returns than bonds.

  • Unlike bonds, dividend stocks can gain value while distributing cash payments, but also unlike bonds, principal is not guaranteed – dividend stocks are subject to the vagaries of the market.

  • Dividend stocks can give retirees and other income investors money to meet expenses without forcing them to sell stocks and depleting the pool of funds they depend on for a living.

  • Dividends are an indication of overall financial health – only mature and secure companies can afford to make regular cash payments to all of their shareholders.

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Dividend producers tend to be elite artists

Paying a dividend is one thing, but companies that consistently increase their dividends over time – the dividend producers – get an extra degree of respect from investors.

Consider the dividend aristocrats.

A small group of stocks on the S&P 500 – there are currently 65 – the Aristocrats represent a sort of star team of dividend producers. To make the list, a company must increase its dividend every year for at least 25 years in a row without missing a single year, regardless of a recession, bubble, downturn or crash.

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Only the most stable, best managed, and most financially secure businesses can achieve such an impressive financial feat, and it shows in the bottom line.

A 2021 report from Hartford Funds shows an undeniable link between dividend growth and shareholder earnings. If you had invested $ 100 in 1973, here is what you would have had in 2020 according to the dividend growth policy of the companies in which you invested it:

  • Dividend cutters and eliminators: $ 56

  • Non-dividend payers: $ 844

  • No change in dividend policy: $ 2,189

  • S&P 500 Equal Weight Index: $ 3,764

  • Dividend payers: $ 6,946

  • Dividend producers and initiators: $ 11,364

If you’re willing to pay an expense ratio of 0.35%, the ProShares NOBL ETF tracks the S&P 500 Dividend Aristocrats Index.

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Dividends: the slow and steady DRIP of oversized earnings

It’s not just the performance of the market. Dividends can have a powerful cumulative effect when you reinvest them instead of reaping them in the form of cash payments. Dividend Reinvestment Plans (DRIPs) allow you to do just that. When you reinvest more dividends, you own more stocks, which then pay more dividends which will then be reinvested to buy even more dividend paying stocks.

Over time, the snowball effect creates a self-sustaining wealth-generating machine that serves as the backbone of the stock market.

In the 50 years between 1970 and 2020, 84% of the S&P 500’s total return came from reinvested dividends and the magic of compound growth, according to the Hartford Funds study. If you are wondering whether you should sign up for a DRR, consider the following. If you had invested $ 10,000 in the S&P 500 in 1960 without reinvesting your dividends, you would have had $ 627,121 in 2020. If you had reinvested your dividends, you would have just under $ 3.85 million.

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Last updated: July 21, 2021

This article originally appeared on GOBankingRates.com: Dividends: Why Are They Important to Your Investment Strategy?


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