If you’re looking for an investment-income source, you may want to consider adding dividend-paying stocks to your portfolio. It is common for investors — especially retirees — to look for income from dividend-paying companies, but there are other benefits as well. Dividend-paying companies in the S&P 500 Index have provided: better potential long-term performance; the ability to reinvest dividends; stability in turbulent markets; and possible tax advantages since 1972.
Dividends have given investors a head start on performance — research indicates that since 1926 about one-third of investors’ total returns have come from dividends. In addition, people are often surprised to learn that dividend-paying stocks have delivered better long-term returns than those that don’t pay dividends. The chart pictured towards the bottom of the page depicts that dividend-paying stocks have outperformed non-dividend payers considerably since 1972. Most significant is the statistic that companies with a growing dividend have outperformed their fellow dividend payers with a static dividend.
If you don’t need the income, you can reinvest the dividends in additional shares of stock and potentially benefit from the effects of compounding (generating earnings from previous earnings). Plus, the value of your stock could go up due to price appreciation. Keep in mind that you must still pay tax annually on dividend income — even if it’s reinvested.
Research shows that predictable cash dividends can be important to overall returns providing stability in turbulent markets. These stocks may experience less volatility than stocks that don’t pay dividends because once cash dividends are paid, they have helped limit downside risk. Interestingly, when the stock market declines, investors tend to seek out dividend-paying stocks which in turn boosts their prices. It’s also notable that dividend-paying businesses that are growing typically increase their dividend over time.
Dividends are also appealing because they can receive favorable tax treatment. For investors in higher income tax brackets, the tax rate they pay on qualified dividend income can be considerably less than the tax rate they pay on their other types of ordinary income, such as interest.
In summary, dividend-paying stocks offer benefits beyond being a potential source of income — so keep them in mind whenever you are considering investing in equity securities.