Investing Can Pay Dividends

September 8, 2020

By Nathan Gilbert

When most people think about investing in stocks, they tend to think in terms of buying a stock at a low price and selling at a higher price. This is certainly the goal whenever buying a stock, but what many often forget about is that some companies also pay their shareholders dividends every quarter. Investors are rewarded for simply holding the stock, and while the hope is the price will also go up, dividends can provide a consistent source of income without have to sell in order to make money.

Dividend stocks are often considered somewhat “boring,” since most of the companies that pay dividends are fairly consistent performers. Their prices usually don’t fluctuate as much as their non-dividend (growth) counterparts, and they may not offer as much of an upside with their stock price. However, if you are someone who is relying on income from your investments, dividends can be a great resource. While not specifically designed for income investors, the S&P 500 Index has a current dividend yield of 1.7%. Unsurprisingly, that is low based on historical standards, but it is still a pretty good rate to earn while you wait for a price increase over a longer timeframe.

Note that dividends are not guaranteed! Companies can decide to reduce payouts or eliminate them entirely depending on their financial position. Hence the lower current dividend yield of the S&P 500. Some of the companies in the index have cut their dividend, due to disappointing earnings tied to the pandemic. As with most investments, the more risk you are willing to take, the more potential you have for a higher return.

If you are someone who can stomach the ups and downs of a stock price, then owning a diversified mix of dividend paying stocks will provide you a much better payout than Certificate of Deposit (CD) interest at a bank. Yes, your bank principal is protected, but you are giving up a lot of potential return. This is certainly NOT a recommendation to buy or sell, but IBM is a good example of a “good” dividend paying stock. Which scenario would you choose?

Own IBM stock over the next 5 years (with risk of price fluctuation) and a 5.23% annual yield (that rate could change)
Own a 5-year CD from a bank with protected principal and a 1.5% annual yield (best rate I could find on bankrate.com)

I certainly know which one I would choose. As always, your answer will depend on your comfort level with risk and your particular situation.

Speaking of paying dividends, investing in education should pay dividends for your children. That’s the hope anyway. As my kids have their first day of “virtual” school today, we are quickly discovering that we may need to invest more heavily in technology in order to make their experience a smooth one! It should be an interesting quarter (please not the whole year! 😊)! All the best to the teachers and parents out there!