It’s been a volatile and difficult year for investors in the broad stock market, and tech-stock investors have had it even worse. If you invest in dividend stocks, however, you’re probably doing somewhat better. There’s a good reason for that, says Sam Stovall, chief investment strategist at CFRA research. “Dividend stocks reduce your overall volatility,” he says. “Dividend payments offer a cushion to offset price declines.” Case in point: The S&P 500, a yardstick from the broad stock market, is down about 16% so far in 2022. An index tracking technology stocks in the S&P 500 is down about 23% on the year and still sits solidly in bear market territory — defined as a decline of 20% or more from recent highs. The FTSE High Dividend Yield Index, which tracks the return of large- and medium-sized companies that pay the highest dividends compared to their share prices, is down just over 5% on the year. But dividend stocks aren’t just handy when the going gets tough. Stovall notes that since 1945, reinvested dividends have contributed 33% of the total return in the S&P 500. “Essentially, dividends can improve your performance by a third without doing anything,” he says. “You can add octane to your performance just by owning dividend-paying stocks.”
Why dividends boost stock returns
Even if you didn’t know it, you likely already own some dividend-paying stocks. Some 400 stocks in the S&P 500 pay one. Here’s how it works. When a company earns excess profits, it has a number of choices for how to use the money. It might reinvest in the business, say, by opening new stores or funding research into new product lines. But many companies — especially large, financially mature ones — choose to distribute some of that money back to shareholders as a sort of “Thank you, please stick around.” These regular cash payouts are a stock’s dividend. Investors have a choice when it comes to dividends, too. If you’re a retiree, you might take that cash payment and using it as spending money. For younger, long-term investors, the common move is to reinvest the dividend back in your portfolio. To understand how that can boost your investment performance, calculate a stock’s dividend yield by dividing the amount of cash you receive annually from a single share of stock into the share price. If you own a stock that’s worth $50 per share and you get $1 for every share you own, that stock yields 2%. By adding this dividend yield to a stock’s price return – the percentage it moves up or down in share price – you can find the total return you earn from an investment. If your stock goes up 10% and yields 2%, you’ve earned a return of 12% on your investment. If the same stock declines by 5%, that 2% payout brings your total return up to 3%.
Stovall’s 33% number represents the difference between the S&P 500’s price return and its total return since 1945. In more recent years, the difference has been more stark: Since 1988, the S&P 500 has moved up a cumulative 1,455% in price, according to FactSet data, meaning a $10,000 investment would now be worth $155,500. Add in reinvested dividends, and you can see the power of compounding interest on the extra cash take hold. Factoring in total return, a $10,000 would now be worth $329,300. That means dividends accounted for a whopping 68% of the broad market’s total return over that period.
How to add dividends to your portfolio