March Market Recap – How Important are Dividends?
Here is a recap of market performance for the month of March and year-to-date:
Stocks increased during the month of March, with US large cap and international stocks leading the way. US small stocks were positive, but lagged for the month. Year to date, small cap is the clear leader, while large cap and international have also posted impressive returns. Bonds continued to struggle for both the month and the year, having negative returns over both timeframes.
How Important Are Dividends?
Lately, we’ve been receiving questions about the role of dividends in an investment portfolio. The following chart from Charles Schwab shows how dividends and price appreciation have contributed to total returns over 95 years of stock market data:
Here are some key points to consider regarding dividend investing:Here are some key points to consider regarding dividend investing:
- Dividends are meaningful – The far right bar of the graph shows that since 1926, dividends have accounted for 4.1% of annualized total return to investors. This means about 40% of returns are attributable to dividend payments, which is quite significant.
- Dividends are reliable – While dividend income has decreased over the past three decades, it’s a much more predictable source of return than the increase in stock price. For example, dividends have contributed between 1.8% and 6.2% annually to returns, while price return has ranged between -5.3% and 15.3%. This shows the price of a stock is much more volatile than the dividend payout. Companies hesitate to lower dividends, because it often implies financial trouble which could prompt some investors to sell.
- Dividends mean spending less money elsewhere – Businesses have limited options for how to allocate profits. They can pay a dividend, retain the money for later use, pay down debt, or use it to expand. Each of these choices has a potential rate of return associated with it. Typically, the highest returns happen when a company grows. Paying a high dividend signals a more mature company that isn’t growing as fast as it used to.
- Dividend stocks are not bond substitutes – One key difference between bonds and stocks is that bonds mature on a specific future date. This distinction makes bonds less volatile, because the time period considered is defined and much shorter. During periods of market anxiety, like we saw during the initial onslaught of the pandemic, bonds hold up much better than stocks, including high-dividend payers. This table shows the returns of three funds during the pandemic crash in 2020:
As you can see, high-dividend stocks (VYM) declined by roughly the same amount as the S&P 500, while lower-yielding bonds (AGG) delivered much better total returns.
So while dividends are an important consideration when selecting an investment, like so many aspects of investing, it shouldn’t be viewed in isolation. The total rate of return is the most relevant metric to optimize, and other important factors contribute to it.
If you would like to discuss this further, please let your advisor know.