Gains are good.
All investors can agree on that. But what I find shocking is how many of my stock-jock friends disregard dividends. To them, sharing in a company's profits and including dividends to improve total returns is almost like, well, cheating.
If that's the case, then let us all be stock market cheaters!
That's right: Cheaters. Why? Because dividends are a huge driver of growth for the individual investor -- accounting for more than 40% of the S&P 500's gains since 1926. Moreover, dividend payers have outperformed non-payers by 3% over the past 25 years, according to Standard and Poor's. Sound small? Consider: $5,000 compounded annually for 25 years at 5% would leave you with nearly $17,000. Add in that extra 3%, and $5,000 compounded annually for 25 years (at 8%) would leave you with nearly $35,000. That's a big difference!
The value of $1
It's true that there was a time when not all dollars were created equal. But any bias against dividends stems from the days before the Jobs & Growth Tax Relief Reconciliation Act of 2003. Before that bill was signed into law, dividends were taxed at rates higher than those for capital gains. In other words, dividend dollars were worth less than capital gains dollars.
Unfair? Absolutely. But that injustice has been rectified so that qualified dividends are now taxed at the same rate as capital gains -- which is why now is a perfect time to make room for dividends in your portfolio. By finding a few dividend payers with capital appreciation potential, you can benefit from steady cash inflows and the random, but generally upward, walk of the market made famous by Burton Malkiel.
Dividends and capital gains
Let's say you caught the Amazon.com
What if you'd jumped aboard a boring dividend payer like UST
So what's it gonna be: 12% and sleepless nights or 14% and easy breathing?
A few more examples
Of course, this is just one example over a randomly selected time frame, but historically we know that dividend payers best non-payers by approximately 3%. Over the past seven years, UST outperformed Amazon.com by 2.5%. Coincidence? Maybe. So let me add more examples to the mix:
| Company | Total annualized return since July 1998 |
|---|---|
| Amazon.com | 11.5% |
|
Dell |
5.4% |
|
Oracle |
17.4% |
| Non-dividend-payer average | 11.4% |
| UST | 14.0% |
|
Jefferson-
Pilot |
6.5% |
|
Arthur J. Gallagher |
18.0% |
| Dividend-payer average | 12.8% |
And if this is too small a sample for your liking, take a look at how iShares Dow Jones Select Dividend Index has outperformed the Nasdaq100
Foolish final thoughts
The key to putting dividends to work in your portfolio is to find companies that combine an outsized and reliable yield with the potential for capital appreciation. That's the strategy Fool analyst Mathew Emmert employs on behalf of his Motley Fool Income Investor subscribers. To date, his recommendations -- including Arthur J. Gallagher -- are besting the S&P 500 by six percentage points. That's better than the historical average and proof that there are rewards to be gained by carefully selecting your stocks. To take a look at Mathew's 50 active recommendations, consider a 30-day free trial. You'll have access to all of his buy reports and advice for free without any obligation to subscribe.
If you find the market's slower and steadier rides boring, then I encourage you to take a deeper look at the historical numbers. After all, a dollar is a dollar -- whether it comes from dividends or capital gains. They all spend (or save) the same.
Tim Hanson owns shares of none of the companies mentioned in this article. At The Fool, no one is too cool for disclosure ... and Tim's pretty darn cool. Amazon.com and Dell are Motley Fool Stock Advisor recommendations.
