Since the dawn of modern markets, rewards to stock investors have come through two streams: price appreciation and dividends. The former is loud, pretentious, and steals the show. It commands the room and makes you think it’s the only force that matters. The latter is quiet, unassuming, and often forgotten. It toils in the corner, away from the spotlight. In the short run, the work of dividends appears insignificant. But don’t be too quick to dismiss its power. When you add compounding and patience to the mix, magic happens.
Caleb posed the following question in the clubhouse:
“I am curious to know other people’s thoughts/opinions on dividends. It seems that it’s a cool idea to get passive income routinely, but does it ever amount to much? I mean, for example, does 500k even get you very much dividend yield in even the best dividend-yielding stocks?
Personally, it seems nice, I can’t seem to fit them into much of my overall plan. “
A blog-worthy query
First, routinely capturing passive income is indeed a cool idea. Super cool, in fact. Many stocks pay dividends, particularly larger companies with sound balance sheets and consistent income streams. ETFs that hold dividend-paying stocks will forward those payments to shareholders as well.
For example, SPY, the ETF for the S&P 500, pays a quarterly dividend of $1.384, or $5.54 annually. Of course, to get that cash, you have to buy one share of SPY for $300. So, getting paid $5.54 for a $300 investment works out to a 1.84% yield or rate of return.
Let’s say you bought SPY for $300 and it stayed at that price for the next year. If you only focused on price appreciation, you would erroneously think you didn’t make any money. But you did! You received $5.54 in four quarterly payments of $1.384.
The second part of the question focused on whether or not dividends ever “amount to much.” Here’s my answer.
In the short run, no.
In the long run, 100% yes.
It also depends on how much invested capital we’re talking about. Raking in 1.84% on $10k over the year only works out to $184. I suspect most people wouldn’t get excited over that.
But if I have $500k in it, well, now we’re talking! A half-million bucks in SPY generates an annual income stream of $9,200. That moves the needle in my book. And we’re not even talking about a high dividend-paying stock.
What if you owned a telecom company like Verizon that pays a 4% dividend? Your $500k would net you $20k in cash flow per year. Not that I would recommend throwing the whole thing in a single stock, mind you, but you get the point.
Dividends Reinvested
The real magic happens when you reinvest your dividends. Take VZ, for example. You got paid $20k this year. What if you used that to buy more shares? If you did, then next year your cash flow would increase by $800 (20k x 0.04) to $20,800. The year after it would increase by $832 (20,800 x 0.04). So on and so forth.
Reinvesting dividends generates compounded growth. Here’s the most eye-popping stat I’ve come across that illustrates the power. It comes from Jason Zweig’s version of The Intelligent Investor:
“According to Professors Elroy Dimson, Paul Marsh, and Mike Staunton of London Business School, if you had invested $1 in U.S. stocks in 1900 and spent all your dividends, your stock portfolio would have grown to $198 by 2000. But if you had reinvested all your dividends, your stock portfolio would have been worth $16,797! Far from being an afterthought, dividends are the greatest force in stock investing.”
Hellooooo Nurse!
If you want more of my articles on dividends, check these out:
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2 Replies to “Options Theory: Are Dividends Worth It?”
This is great! Thank you Tyler for this well thought out answer.
I like dividends, I try to put about 5% in higher paying divs and 5% on just what ever I like. My only issue with then is that they need to be in an IRA account to avoid the tax implications. I was making 20k a year in dividends with just passive involvement. When I was not actively trading I reinvested then. Now as an active trader I take some and use it to support other trading opportunities.
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