Investing in stocks is not for the faint of heart. Honestly.

Did you know, for example, that there's a respected tool called the Ulcer Index? It's a technical way of calculating an investor's risk. The very existence of an Ulcer Index should make it clear that investments rarely go in a straight, steady, upward line.

That has been crystal clear these past few months, with stocks vacillating between recession-fueled panic and bailout-supported euphoria. Checking your stocks in this environment may well be a recipe for an ulcer.

Of course, that also makes now the perfect time to refocus your investment strategy on its long-term potential.

Put time on your side
Where can you find significant long-term potential? In dividends. Though quite often maligned, ignored, and otherwise misunderstood, they really do make all the difference over time -- because the big benefit those dividends bring to the table is that they can be reinvested.

In his book The Future for Investors, Wharton Business School Professor Jeremy Siegel studied the entire history of the Standard & Poor's 500 index. Among his most important conclusions was this: "Dividends matter a lot. Reinvesting dividends is the critical factor giving the edge to most winning stocks in the long run."

Why? Because in essence, you take the cash thrown off by your investments and turn around and buy more shares with it. When you're just starting out, the $20 to $40 or so you might expect to receive each year on each $1,000 investment may not seem like much. Over time, though, all those little dribs and drabs add up to quite a tidy sum.

How tidy?
Say you sock away $5,000 every year for the next 40 years, and invest it in a collection of dividend-paying stocks that yield an average of 3%. Let's further suppose that this collection of stalwart companies combines to return 4% per year (on average) for the duration of your investment.

Should you stick those stocks in a tax-sheltered IRA and reinvest the dividends? Or put them in a regular account where you can keep and spend the dividends?

The choice over what to do with $150 may seem nearly meaningless in the first year or so, but as this chart shows, your account will grow quite a bit faster if you let those dividends compound on your behalf:


Take as Cash







































Year-end balances. Assumes each investment is made at the beginning of each year.

Wouldn't you rather forgo spending the $150 up front and instead pocket an extra $574,000 at the end of the line?

Is that realistic?
It's quite an accomplishment for a company to both provide a significant dividend and grow that payment at a decent clip for decades on end. However, it has been done. The following handful of firms, for instance:

  • Carry at least a 3% yield.
  • Have paid higher dividends every year in each of the last 10 years.
  • Have increased their dividends over the past decade by a better-than-8% annualized rate.




Allstate (NYSE: ALL)



CBL & Associates (NYSE: CBL)



General Electric (NYSE: GE)



General Growth Properties (NYSE: GGP)



Kinder Morgan Energy Partners (NYSE: KMP)



Eli Lilly (NYSE: LLY)



Pfizer (NYSE: PFE)



Foolish conclusion
Yes, a decade is hardly 40 years, but as you look for new investments in this rocky market, remember that strong dividends and strong growth can combine to create an unbeatable long-term investment.

Our Motley Fool Income Investor service is beating the market by more than six percentage points by owning companies that behave like those described. What's more, the average pick now has a yield of more than 5%.

You can see our entire lineup of dividend stocks for free with a 30-day trial.

At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric and of Kinder Morgan Management, a related company to Kinder Morgan Energy Partners. At the time of publication, Chuck's wife owned shares of General Growth Properties. Eli Lilly and Pfizer are Income Investor recommendations. Pfizer is also an Inside Value selection. The Fool has a disclosure policy.