By Amy Smith
It wasn’t so long ago that many investors regarded dividends as roughly the financial equivalent of a record turntable at a gathering of MP3 users – a throwback to an earlier era, irrelevant to the real action.
But fast-forward a few years and things look a little different. Since 2003, when the top federal income tax rate on qualified dividends was reduced to 15 percent from a maximum of 38.6 percent, dividends have acquired new respect. Favorable tax treatment isn’t the only reason, either; the ability of dividends to provide income and potentially help mitigate market volatility is also attractive to investors. As baby boomers approach retirement and begin to focus on income-producing investments, the long-term demand for high-quality, reliable dividends is likely to increase.
Why consider dividends?
Dividend income has represented roughly one-third of the total return on the Standard & Poor’s 500 since 1926. According to S & P, the portion of total return attributable to dividends has ranged from a high of 53 percent during the 1940s – in other words, more than half that decade’s return resulted from dividends – to a low of 14 percent during the 1990s when investors tended to focus on growth.
If dividends are reinvested, their impact over time becomes even more dramatic. S & P calculates that $1 invested in the Standard and Poor’s 500 in December 1929 would have grown to $49 over the following 80 years. However, when coupled with reinvested dividends, that same $1 investment would have resulted in $1,259. (Bear in mind that past performance is no guarantee of future results, and taxes were not factored into the calculations.)
If a stock’s price rises eight percent a year, even a 2.5 percent dividend yield can push its total return into double digits. Dividends can be especially attractive during times of relatively low or mediocre returns. In some cases, dividends can help turn a negative return positive; they also can mitigate the impact of a volatile market by helping even out a portfolio’s return.
Finally, many dividend-paying stocks represent large, established companies that may have significant resources to weather an economic downturn, which could be helpful if you’re relying on those dividends to help pay living expenses.
Look before you leap.
Investing in dividend-paying stocks isn’t as simple as just picking the highest yield. If you’re investing for income, consider whether the company’s cash flow can sustain its dividend. If you’re interested in a dividend-focused investing style, look for terms such as “equity income,” “dividend income,” or “growth and income.”
For additional investment insight, please visit my website amysmithwealthmanagement.com. Click on “News and Resources,” where you’ll find the most recent Investment Strategy Quarterly and other investment insights from Raymond James experts.
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©Amy V. Smith Wealth Management, LLC, is an independent firm. Amy is a Certified Financial Planner (CFP) and Certified Investment Management Analyst (CIMA) and offers securities through Raymond James Financial Services, Inc., member FINRA/SIPC. Her office is located at 161 Fort Evans Road, NE, Ste 345, Leesburg, VA 20176. www.amysmithwealthmanagement.com. The opinions and recommendations here are those of the columnist.
The information contained in this report does not purport to be a complete description of the developments referred to in this material and does not constitute a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Dividends are not guaranteed and must be authorized by the company’s board of directors. Investing involves risk and you may incur a profit or loss regardless of strategy selected.