While most investors are publicly celebrating this record-setting bull market, many tell me in private that they’re nervous about the possibility of a downturn.
People have different reactions when the market does so well for so long. Some are sure they should get out, but greed won’t let them pull the plug. Others are eager to get in on the action, but fear won’t let them pull the trigger.
I tell clients to base their decisions on their long-term plan, not what’s happening day to day. Staying on a steady course is always key in investing, but especially in uncertain times.
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One of my favorite ways to add some stability to a portfolio is with a thoughtful dividend strategy — especially if you can reinvest those dividends instead of taking them as income.
What’s the payoff for patience?
Let’s hypothetically say you had put $10,000 in an investment that perfectly matched the S&P 500 at the end of 1960. If you had taken the dividends as cash and not reinvested them, at the end of 2015, your $10,000 would have grown to $351,000.
Not bad. But if you’d reinvested those dividends, you’d have just shy of $1.9 million.
Jaw-dropping, right?
Now, you may not be able to wait 55 years, but even 10, 20 or 30 years could bring you some pleasing results.
And the thing is that most folks, if they’re still working and earning a paycheck, don’t need that dividend income. Oh, it might pay for a vacation every couple of years or so. But if you can keep your hands off and reinvest it, there’s a good chance you’ll see exponential growth. It’s one of the easiest and least expensive ways to increase your holdings over time.
And even after you retire, you may choose to continue growing those investments as you pull from other income streams.
There are various way to handle reinvesting:
- You can enroll in a dividend reinvestment plan (DRIP).
- You can buy a low-cost fund that automatically reinvests distributions for you.
- Or you can stockpile the cash until you decide to make a purchase on your own. (I’d avoid the third option unless you are both market savvy and extremely disciplined.)
Keep in mind that, no matter which method you choose, this is a slow process. You’re not looking for the next big thing, and you want to stay far away from the big thing that’s almost over.
Don’t make the mistake of simply choosing stocks that offer the highest yields possible. Over time, those stocks have not performed as well as those that pay high, but not the very highest, levels of dividends. Why? Sometimes a company will declare dividends to grab investor interest and boost share price, but then it can’t sustain those payments. And if there’s a dividend cut, the market might read that as a sign of weakness.
Look, instead, for stable, well-run companies that pay constant or rising dividends — companies that are going to be here for a while. For example, iconic American brands, even though they may be in mature industries, can be terrific investments. I’m pretty confident we’ll be eating at our favorite fast-food restaurants, drinking popular soft drinks and using those brand-name laundry detergents for years to come.
But do your homework, because even consistent dividend payers can develop problems.
Talk to your financial professional about how dividend stocks might work in your portfolio. Be sure to ask about tax consequences (good and bad) and how your strategy might affect your overall retirement plan.
Most important: Know thyself.
If you are a patient, careful investor, dividend stocks may be just the thing to help take your market anxiety down a notch.
Kim Franke-Folstad contributed to this article.
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