Tuesday, October 7, 2008

Why Dividends are Important

I am not going to try to reinvent the wheel here. There is a lot of research out there that provides us with multiple reasons why dividends are important. However, there is one particular document that I often refer to if I am ever in doubt about my own personal dividend growth strategy. WIth markets like the one we are currently experiencing, it is easy to let emotions get the better of us and to ultimately make stupid and rash decisions. My solution is to re-read two different resources: The Single Best Investment: Creating Wealth with Dividend Growth and The High Dividend Yield Return Advantage (pdf). I am going to summarize the main points of the latter in this post.

Dividend investing has been proven over and over again to be a very rewarding and viable strategy. A research report complete by Tweedy Browne Inc. provides a list of 5 primary reason why dividend growth investing is so successful:

1. Over the long term, the return from dividends has been a significant contributor to the total returns produced by equity securities.
2. Portfolios consisting of higher dividend yielding securities produce returns that are attractive relative to lower-
yielding portfolios and to overall stock market returns over long measurement periods.
3. Stocks with high and apparent sustainable dividend yields that are competitive with high quality bond yields may be more resistant to a decline in price than lower-yielding securities because the stock is in effect “yield supported”. The reinvestment of dividends during stock market declines has also been shown to lessen the time necessary to recoup portfolio losses.
4. The ability to pay cash dividends is a positive factor in assessing the underlying health of a company and the quality of its earnings.
5. Dividends have a more favorable tax rate.

This report does not suggest going out and finding the stocks with huge yields (8%+ in my opinion). Instead, focus on the stocks that pay dividends and more importantly that grow dividends and over the long term history has proved that your portfolio results will be better for it. Most importantly, it is not a short-term strategy and must be used with long-time periods in mind (as all investing should)!

This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.

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