Controversy swirls around whether younger investors can benefit from emphasizing dividend-paying stocks in their portfolios—a practice normally associated with retirees. But evidence suggests that no age is too early to start thinking about income investing.
Growth companies—one argument goes—may be more enticing to non-retirees because they can boost returns quickly. These companies are typically young, agile and plowing earnings back into their burgeoning businesses. Dividend-paying companies, by contrast, are often slower growing, more mature businesses that have more spare cash to pay out to shareholders. Consequently, they are often rightly favored by those nearing retirement, who seek steady, passive income.
But younger investors with ample time before retirement may want to consider the power of reinvesting dividends. To begin with, dividends have contributed roughly a third of equity returns since 1925. And the impact of reinvesting all those dividends compounds as an investor’s timeline increases. Random snapshots of various time horizons tell a consistent story.
For instance, for the 10-year period from September 1, 2005 through August 1, 2015 the S&P 500 returned 66% without dividends reinvested, and 74% with dividends reinvested. Not bad.
Over longer terms, however, the story becomes more dramatic. The S&P 500 index returned 455% from 1988 to 2013, but with dividends reinvested it delivered a 963.5% return, according to S&P Dow Jones Indices research. Zooming out even further, for the period of December 1960 through December 2012, the S&P 500 without dividends returned 2,354%, versus 12,314% with reinvested dividends.
When selecting dividend stocks, price appreciation is often a secondary consideration to the dividends themselves. And yet, some research shows that over the long term, dividend stocks can outdo growth stocks even when it comes to price appreciation. An Ibbotson study examining stock performance for the period of 1969 – 2002 found that value stocks returned an annualized average of 10.99%, compared to 8.79% for growth stocks.
Of course, past performance is never a guarantee of future results. But younger investors—even those who are just getting started—will want to consider the impact of reinvesting dividends over the long-term horizon. This potential for compounded returns, in addition to the relative stability of the companies that are most likely to pay them, can make them an important piece of a diversified long-term portfolio.
Average annual return figures reflect the geometric mean. http://corporate.morningstar.com/ib/documents/MethodologyDocuments/IBBAssociates/IbbotsonStyleIndices.pdf