The Power of Dividends

Did you know that almost 75% of the returns in the S&P 500 over the last twenty years came from dividends? Investing in the stock market carries a certain level of risk, but by owning dividend paying stocks you can help to reduce risk over time.

What are dividends? They are a distribution of cash to shareholders, normally paid on a quarterly basis. Dividends are typically paid out as a portion of the profits earned by the company. Dividend yields represent the income as a percentage of the share value that you can expect to receive. If you own 100 shares of Exxon Mobil at $88 a share with a dividend yield of 4%, you could expect to receive dividends of $352 annually, or $88 quarterly. As dividends are paid out you can chose to receive them in cash, or have them reinvested automatically to purchase additional shares.

Why purchase dividend paying stocks? Companies that pay dividends are generally financially stable and good stewards of capital, which inherently reduces the risk of owning the stock. By paying out dividends, companies also tend to have more shareholder loyalty. If there aren’t as many people selling the stock, the price tends to be more stable. Dividends also provide a quarterly reminder of why you own the stock. The reliable income from dividends is also very appealing to those looking to supplement their income.

Should you receive the dividends paid in cash or have them reinvested? That answer depends entirely on why you own the stock. If you are retired and need to supplement your income, dividends can help to provide the needed shortfall. If income isn’t a concern to you now, then reinvest the dividends and focus on accumulating more shares of the stock through dividend reinvestment. Over time the snowball effect will kick in and provide significantly more income at a time when you might need it. Keep in mind that you can always alter the way you are receiving your income. A lot of clients tend to have dividends reinvested during their working years, and as they start approaching retirement, they flip the switch and start receiving them in cash.

Here is a powerful reason why you should consider reinvesting your dividends. Assuming you invested

$10k in Coca Cola (KO) 20 years ago and allowed the dividends to be reinvested quarterly, your shares would now be worth over $44k. Had you elected to receive the dividends in cash, your total share value would be $33k. Simple math shows a difference of $11k, but what it doesn’t show is that by reinvesting the dividends you ended up with 680 shares vs. the initial 382 shares purchased 20 years ago.

How are dividends taxed? Most dividends paid by US companies are considered “Qualified Dividends” and therefore have a more favorable tax treatment than other forms of income. For households with federal income tax rates of 12%-35%, the tax on qualified dividends is 15%. Those that fall below this tax bracket would not be subject to income tax. The cap tax rate is 20% and only applies to those in the 35%-37% tax bracket (income greater than $445,850). For individuals with adjusted gross income exceeding $200k or $250k for married couples, there is also an additional 3.8% net investment income tax applicable. If the dividends paid are not classified as “qualified” then they would be subject to tax at your current tax rate. Examples of non-qualified dividends would be those paid from master limited partnerships (MLP’s) real estate investment trusts (REIT’s) and many foreign stocks.

Overall I think there are countless benefits to dividend paying stocks and believe there is a spot for them in most portfolios. If you would be interested in discussing how best to implement them in your investment strategy, please feel free to give us a call.

Opinions expressed are those of the author and are not necessarily those of Raymond James. This is a hypothetical illustration and is not intended to reflect the actual performance of any particular security. Dividends are not guaranteed and must be authorized by the company's board of directors. Future performance cannot be guaranteed and investment yields will fluctuate with market conditions.

Investing involves risk and investors may incur a profit or a loss regardless of strategy selected.