In an investors' utopia, we would all be able to earn market-beating returns with no effort and next to no cost. I'm here to tell you that this doesn't exist ... but you can get close.
You can get returns that match the market with no effort by simply loading up on an index fund in your retirement account. But with a strategy that is focused on dividend payers and regular reinvestment, I believe beating the market is possible with just a little bit of effort and a reasonable cost.
Where the effort comes in
Nobody gets paid for doing absolutely nothing. Even if you own a stalwart that has delivered massive dividend-adjusted returns for the last 30 years, such as Altria's (NYSE:MO) annualized 31%, you still have to pay attention on a quarterly or semiannual basis. The effort comes in finding and assessing companies that can be held for the longer term, keeping up with their performance on a three- to six-month basis, and regularly reinvesting the dividends you receive.
I know many investors are intimidated by the math or effort and time required to perform a valuation analysis on a company. The good news is that companies that carry yields greater than 2.5% are rarely extremely overvalued. It can happen, and I still recommend attempting to assign a value to every company before purchasing it, but with a healthy yield it is reasonable to spend more time focusing on a company's balance sheet and its ability to fund its debt, continue its dividend, and grow over the long term.
The final piece of effort comes in reinvesting your dividends. Reinvesting is what makes up for more pedestrian gains in share price, and it works wonders over the long-term. Owning 100 shares of Wells Fargo (NYSE:WFC) at today's price of $64.40, having them go up 8% a year for the next three years, and ending up with $8,737 ($8,112.55 in stock and $624 in dividends) is nice. But having the shares go up 8% a year and reinvesting the 3.3% dividend yield to end up with 105.76 shares worth $8,787.80 is a little bit nicer.
That's over only three years. The gains from reinvesting widen as the years progress. This is how investors that hold seemingly sleepy high-yield companies like 4.3%-yielding Packaging Corp of America (NYSE:PKG) somehow end up beating the market.
Beware of fees in reinvesting
Fees are the bane of investing. For a long time, dividend reinvestment plans (Drips) were fee-free, but more and more companies -- Ford (NYSE:F), for example -- are charging fees for purchases, dividend reinvestment, and sales. However, some companies out there, such as General Growth Properties (NYSE:GGP) and Abbott Laboratories (NYSE:ABT), still only charge investors a reasonable fee when they sell, which should be many years in the future.
The other option is to reinvest your dividends yourself. With an account that has $50,000 and yields 3%, you'd receive $1,500 in dividends in a year. Under such a scenario it should be possible to reinvest your dividends twice a year, pay $15 per trade, and still keep commissions below a reasonable threshold of 2% per transaction.
Foolish final thoughts
Keeping investing simple and still having a shot at beating the market requires patience more than anything else. But over time, keeping transaction costs and taxes to a minimum, buying beaten-up stocks without worrying about getting heckled, and allowing dividend reinvestment to power returns will give you an advantage over the market. This is particularly true if you are invested in an IRA that allows you to defer the taxes for the dividends you receive.
Market-beating returns through dividend-paying stocks are what Mathew Emmert looks to deliver in our Motley Fool Income Investor service. For more than two years, Mathew has bested the S&P 500 by more than three percentage points on the backs of selections such as hotel REIT Equity Inns (NYSE:ENN), which has returned 49%. Be our guest free for 30 days and you can see all of Mathew's recommendations. You'll also be able participate in our online class on valuation and discounted cash flow analysis. Click here to learn more.
Nathan Parmelee does not own shares in any of the companies mentioned. You can view his profile here. The Motley Fool has a disclosure policy.
