Yes, the benefits of stocks are critical to baby boomers, because of the income provided and lower volatility. This strategy, however, has also been shown to beat the market. Maybe just this once you can have your cake and eat it, too.
Don't be seduced by growth
Don't worry, I hear you. I know how seductive growth can be, because I've made the mistake myself. It's very hard to look at companies growing 20%, 30%, 40% and walk away. Our brains are wired to take recent strong earnings growth and share price growth and make the mental leap to more of the same in the future. The next thing you know, your portfolio is littered with Sun Microsystems
The real kicker is that these aren't necessarily bad companies, but it's very likely that you're paying too much for them. Worse, high-growth companies mostly don't pay any dividends, which means your entire return is tied to share price appreciation that may or may not come.
In Cisco's case, shares are still below where they were six years ago and this company is more than capable of paying a reasonable dividend without sacrificing growth opportunities. Instead, management is repurchasing shares, but due to all the dilution over the past few years, these repurchases don't benefit investors like they normally would. When Cisco is ready to reward its investors, it will pay a dividend.
A simple, free example
A great free example of dependable dividend payers trumping the market over the long term is available for view at no cost every day on Berkshire Hathaway's website.
Every spring, Warren Buffett sends out a letter to shareholders and an annual report. This act in itself isn't very special, since it's legally required. But what is special is that every year Berkshire Hathaway discloses an itemized list of companies in which it owns shares worth more than $600 million. Companies such as the Washington Post Co.
That Berkshire Hathaway does not pay a dividend is not lost on me. I honestly hope it will. But Buffett has proved time and again that he is outstanding at allocating capital, a rare trait in a CEO. Also, I wouldn't read into this that Buffett requires his investments to pay dividends, but he does insist on investing in companies with durable businesses that treat shareholders like owners, which means he's likely to end up with dividend payers.
Better bear market protection and recovery
The truly beautiful thing about investing in good old-fashioned dividend-paying companies is that often you can reinvest your dividends for free, either directly through a company dividend reinvestment program or via a number of brokers. Reinvesting dividends produces beautiful results, because your dividends allow you to dollar-cost average into more shares and the reinvested shares magnify your returns as the market recovers. The dividends also provide a floor under the share price that non-dividend-paying companies lack. I've outlined a couple of examples in the last few weeks that detail how impressive these returns are.
In his latest book, The Future for Investors, Jeremy Siegel writes that portfolios invested in the highest-yielding stocks, on average, returned 3% more than the S&P 500, because of reinvested dividends. According to Siegel, 97% of stocks' total return after inflation from 1871 to 2003 came from reinvesting dividends, while only 3% was derived from capital gains. These two facts are worth their weight in gold when deciding between whether to build up a position in XM Satellite Radio
Foolish wrap-up
The idea that dividend-paying stocks are only for retirees or baby boomers close to retirement is a farce. This is a strategy that works for all investors. Whether you're a retiree, baby boomer, or Gen Xer, reinvesting dividends in one form or another deserves serious consideration, because the benefits of such a strategy are too good to ignore. This doesn't mean speculating can't be a portion of a portfolio, but it should be a small one surrounded by solid income-producing investments.
If you'd like to learn more about becoming an income investor, please consider a 30-day free trial to the Fool's Income Investor newsletter. In each issue, lead analyst Mathew Emmert recommends two new investment opportunities -- and each is accompanied by information on dividend reinvestment options. A free trial gets you the most recent issue, the ability to view back issues, and access to our discussion boards, where like-minded investors share ideas and discuss income-investing strategies. If you're not completely satisfied, we'll refund your money. No questions asked.
Nathan Parmelee loves summer days in New England as much as dividend checks. He owns shares in Berkshire Hathaway, but has no financial interest in other companies mentioned. You can view his profile here. The Motley Fool has an ironclad disclosure policy.
