Dividend-paying stocks have been a lifeline for many investors since the start of the bear market about 18 months ago. Investors flocked to high-yielding dividend stocks, not only because they generated income, but because they also produced, in many cases, better total returns and are typically distributed by stable companies built to weather market storms.
So far in 2023, the markets have improved, although another correction is certainly possible. Is it still a good time to invest in dividend stocks? It depends on a few factors, but for some, it may make sense to dial back on income stocks. Here's why.
1. You don't need the income
Dividend stocks are typically held by individuals in their retirement years as a way to boost income and generate steady, solid returns at a time in your life where you don't need as much growth, or volatility, in your portfolio.
That logic got turned on its head during the worst market in almost 15 years, as returns were so bad that dividend stocks provided some much-needed income amid a sea of red numbers in a portfolio. Also, the reinvested dividends helped boost the total return of many stocks, which is a big reason good dividend stocks outperformed the market.
Image source: Getty Images.
So far in 2023, the S&P 500 is up about 8% while the Nasdaq Composite is up roughly 16% year to date. Although the market could suffer another correction, the extremely overvalued market of late 2021 that preceded the bear market has eased, which means things are a little closer to normal and there are a lot of good, cheap growth stocks out there right now.
So, although dividend stocks still serve a valuable purpose in a portfolio for many retirees, as well as conservative investors, those with longer time horizons may want to dial back on some of their dividend stocks to put money into shares with more potential for appreciation.
2. You want to generate better long-term returns
As mentioned, dividend stocks are a favored investment in times of bear markets or recessionary environments. If you look at past down markets, dividend stocks have buoyed the S&P 500. In the 1970s, for example, when inflation was high, the economy went through a protracted recession, and the stock market was down, dividends accounted for 70% of the total return of the S&P 500. Conversely, in the bull market of the 2010s, dividends accounted for less than 20% of the market's total return.
Now, inflation is high, and many economists believe a recession is coming, so dividend stocks may still have great significance for some investors, particularly in the short term.
But over a longer period, growth stocks have a history of generating superior returns. Consider the performance of two representative exchange-traded funds (ETFs) to support of that premise. The Invesco QQQ (QQQ -1.10%), which tracks the Nasdaq 100, has generated an 13.5% annualized total return over the past 17.5 years.
The reason I go back 17.5 years to Nov. 8, 2005, is to show the contrast with the SPDR S&P Dividend ETF (SDY -0.56%), one of the oldest and largest dividend ETFs. That was the inception date for the fund, and since then it has an annualized total return of about 8.9%.
During the past 10 years, the gap is even wider, as the QQQ has an average annual total return of 17.3%, while the SPDR S&P Dividend ETF has returned 10.4% on an annual basis.
This is meant to illustrate that, for those who are investing for the long term, dividend stocks, while they should play a role in your portfolio, probably won't deliver the capital appreciation over time that you can get elsewhere.
