Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on successful investing. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away. Today’s tip: “Dividends can produce a large part of your total return over long periods.” Dividends rarely get the respect they deserve, especially from beginning investors. That’s because a dividend paying stock’s yearly 2% or 3% or 5% dividend barely seems worth mentioning alongside possible yearly capital gains of 10%, 20% or 30% or more. But dividends are far more reliable than capital gains. A stock that pays a $1 dividend this year will probably do the same next year. (It may even raise the rate to $1.02). A couple of decades ago, you could assume that dividends would contribute up to a third of your long-term investment returns, without even considering the tax-cutting effects of the dividend tax credit. Earlier in this decade, dividend yields were generally too low to provide a third of investment returns. But now that yields have moved up and interest rates have moved down, it’s realistic to assume they will once again contribute as much as a third of your total return. In addition:
- Dividends can grow. Stock prices rise and fall, so capital losses often follow capital gains, at least temporarily. Interest on a bond or GIC holds steady, at best. But dividend paying stocks like to ratchet their dividends upward — hold them steady in a bad year, raise them in a good one. That gives you a hedge against inflation.
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Dividends are a sign of investment quality. Some good companies reinvest profit instead of paying dividends. But fraudulent and failing companies are hardly ever dividend paying stocks. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks.
For a true measure of stability, focus on those companies that have maintained or raised their dividends during the recent recession and stock-market downturn. That’s because these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.
Next Wednesday, September 29, 2010, Investor Toolkit will look at how to avoid the pitfalls in options investing. If you’d like me to personally apply my time-tested approach to your investments, you should consider becoming a client of my Successful Investor Wealth Management service. Click here to learn more.
