Let me get right down to it: Dividend investing is a superior way to build wealth in the stock market. Here are five reasons you should put dividends to work in your portfolio:
1. Bear market protection. This one is fresh on investors' minds because the market is swooning. Perhaps the best benefit of dividend-paying stocks is that they tend not to fall as far as non-dividend-paying stocks in a bear market. But the fact that the dividend payments continue to roll in during market downturns -- which are the absolute best times to be adding new money -- is what really makes the difference.
2. Less volatility. Companies with serious commitments to their dividends can be unbelievably boring. That's a good thing. The healthy yields paid by companies such as Citigroup (NYSE:C) and Income Investor selection Southern Company (NYSE:SO) can act as a brake on a sliding share price. That may seem like a small consolation, but when volatility and bear markets strike, dividend payers rarely cause sleepless nights.
3. Better transparency. One of the painful truths of investing is that I could take three Fools here in HQ and ask for an estimate on the valuation of a fairly simple company such as Automatic Data Processing (NYSE:ADP) -- and get three different answers. One person might look at net income and estimate a forward price-to-earnings ratio, the second might look at free cash flow, and the third could make adjustments to either of those figures and arrive at a completely different answer. Dividends, on the other hand, are concrete. Companies state their payouts, and it's far more difficult to fudge the numbers when you have to dole out cash to shareholders.
4. Historically, dividends matter. A lot. Fellow Fool Shannon Zimmerman highlighted just how much -- from 1926 to 2004, 41% of the return in the S&P 500 came from dividends. That seems hard to believe today, now that the yield on the S&P 500 is less than 2%, but it's true. With the effects of reinvesting and compounding accounted for, the returns are simply staggering.
5. Market-beating results. Although it intuitively makes sense that Washington Mutual (NYSE:WM) and TD Banknorth (NYSE:BNK), with yields of 4.6% and 3.1%, respectively, offer investors a solid start toward beating the market, it's by no means proof. For proof I'll look to Wharton professor Jeremy Siegel and his thoroughly researched The Future for Investors. In that book, Siegel shows that the original S&P 500 has outperformed the regularly updated index and that dividend payers such as Altria (NYSE:MO) and Abbott Laboratories (NYSE:ABT) tend to beat the market over long stretches. Why? According to Siegel, they outperform the market because of the benefits of reinvesting dividends during declines.
Foolish final thoughts
Those are just five reasons why dividend investing makes sense -- and why it can help you beat the market. If you think of others, feel free to email me at the address below. And if you want to get started buying the market's best dividend-paying stocks, consider our Motley Fool Income Investor service, where we've recommended more than 50 dividend dazzlers to date. You can view all our picks for free with a 30-day trial. Click here to learn more.
At the time of publication, Nathan Parmelee had no financial interest in any of the companies mentioned. The Fool has a disclosure policy.
