Today I have money on my mind. I’m talking dividends. How you feel about them depends in large part on your trading style. If you’re a short-term tactical trader I’m sure you couldn’t care less about dividends. And, really, why should you? They’re simply not relevant to your time frame, peanuts in the grand trading circus.
And yet, if you’re a long-term investor dividends are divine, a glorious gift delivered to your bank account with stunning regularity.
But perhaps I’m getting a bit ahead of myself. Let’s begin at square one for the rookie traders among us.
Profits! Get Your Profits!
The reason we humans goes into business is to make money. Profits, baby, give me profits. If you have the opportunity to buy into a business, to become a shareholder, you typically only take the plunge if you expect the company to sell the crap out of their wares. And, of course, as a part owner you expect to relish in the spoils. The most common method for public companies to dole out a portion of their profits to owners is through dividends. Consider it a kickback, a thank you of sorts, for being a shareholder.
Lest you’re unaware good old ThinkorSwim displays a company’s dividend in the Trade tab. It’s hidden in plain sight. Simply head over to the Trade tab (yellow box), click the arrow to the left of the stock price (purple circle) and voila! the dividend information is displayed in all its glittering glory (blue box).
As you can see I’ve elected to use the popular S&P 500 ETF (SPY) to illustrate. Every quarter SPY currently pays a dividend of $1.21 for every share you own. If you owned 100 shares of SPY, then, you would receive $121 every quarter, or $484 per year.
The cool kids like to talk about the dividend yield (or, yield for short). Right now the yield for SPY is 2.48%. That number is calculated by taking the annual dividend ($4.84) divided by the share price ($195.54). Even if SPY meanders sideways over the year offering zippo in terms of price appreciation you’d still receive a 2.48% return on investment in the form of dividends.
Not too shabby.
Admittedly, one year is an eternity for short-term traders. Hence their indifference towards the whole concept. Long-term investors, on the other hand, just love those dividends. In the long run these glorious cash rewards can make a world of difference. No joke. Here’s a fascinating stat I came across while trying not to fall asleep reading 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.”
The Money Battle
Suffice it to say, dividends account for a large portion of the returns generated by stocks historically. There are all sorts of fascinating takeaways when you compare the dividend yield of stocks to the yield of savings accounts or bond yields. Think of it. In a zero interest rate world a 2.48% dividend yield starts to look mighty attractive. There stocks sit, seductive as ever, beckoning to money seekers desperate for some income love.
On the flip side imagine savings accounts are yielding 5% (remember 2006?). In that environment the 2.48% in stocks looks downright ugly. Why take risk for 2.48% when you get 5% for free? With a proper understanding of dividends you can better appreciate the eternal battle between asset classes driven in large part by interest rate levels. It’s a constant push-pull as investors the world over weigh the risks and rewards offered by stocks, bonds, and a bevy of other choices served daily in the Wall Street buffet.
As for this business of reinvesting dividends. I’ll pull back the curtain on that next time. We’re just scratching the surface, friends.
Financial freedom is a journey
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