I grew up thinking dividends were lit!
Seriouy though, no one my parents age ever mentioned investing without mentioning dividends. So imagine my surprise when my investment portfolio tells a different story!
In fact, I was recently at an event where a young lady asked me what was the normal amount of money she should expect from dividends (from her tone, I could tell she was disappointed because she wasn't making a lot of money on her investment). I immediately knew that she had no clue. But then I wondered, how many of today's investors really know how much to expect from dividend income? My guess is probably not many.
The reality is, on average, stocks in the S&P 500 pay around 2% dividend yield per year (1.8% to be exact). That means if you have $1000 invested, you'll get $18. But then factor in Uncle Sam, and you'll end up with roughly $15 for the year. Yes, fifteen bucks, that's it! This is likely why the young lady was concerned, and I can totally understand her frustration. To put it lightly, Dividends are hardly the rage these days. But in today's reality, I'd argue that younger investors pay very little attention to dividend return on their stock. And rightfully so. I mean, in market where Amazon stock price grows 300% over a few years, who really cares about a measly 1.8%? We millennials love all things new and exciting, and rapidly increasing in value. But the reality is dividends are boring, basic and a very minor component of today's investment returns.
However, despite the snooze fest, I would argue that dividends are still very important. (I won't insult your intelligence by inserting the definition of dividend here, but if you need a recap, scroll to the bottom of this article.*) In the midst of your Amazon and Netflix stocks doubling and tripling in value, it my be hard to see any reason why a dividend should be worth your time. But here's why you should still care about dividends:
Stable Income.
Dividends are typically seen as a more stable, less volatile source of income from stocks. So although the returns are skimpy, at least you can count on this payout. And a "guarantee" really comes in handy when the market isn't performing well and stock prices are down. Dividend income can help pad your portfolio from losses on stock value. Given the strong bull markets we've had over the last 10 years, everyone's portfolio return has been quite impressive (hopefully), so its easy to scoff at a petty 2% return. But trust me, if the stock market has a few bad years with negative return, you will appreciate those dividends real quick! Also, its highly advantageous to be a company that pays hefty dividends when the market tanks. Your stock will maintain some value in turbulent markets — strictly because of the cash distribution that shareholders receive.
It's cash not being used by the company.
Not all companies pay dividends. In fact, 20% of the stocks in the S&P 500 don't pay dividends at all, including some of your favs (that's right, Google, Amazon, Facebook... pay no dividends ). This is important to mention, because the more dividend cash you pay out to shareholders, the less cash you have to invest in new ideas and grow the company. It's extremely common for technology stocks (which are considered "growth" companies) to not pay dividends. Tech companies are constantly on the brink of the next best thing and birth innovations that could transform our ways of life — so the value of a dollar reinvested in that company is way more valuable than a dollar distributed out to shareholders for a new pair of shoes. Most stock holders understand this principle very clearly: No you won't receive a regular dispersion of cash, but as the company invests in new successful ventures, valuation of the company increases, and so will the price of your stock. Most dividend paying stocks are older, mature companies (think Walmart, Johnson and Johnson, McDonalds, JPMorgan Chase). When a company phases out of the growth stage, paying dividends become far more important. Because if cash is not being used to generate more growth and add more value to the company, then its best use is to be distributed to the stock owners.
Valuation.
There are quite a few popular financial models that evaluate the price of a company's stock based on the dividend payments (I'm sure you care very much about this topic! Zzzz). But without any formal training you can do a quick bootleg, unsophisticated check on the health of a company based on their dividend history. For example, as an investor, I would be extremely concerned if the company of a stock I own started to decrease the amount of dividends they paid out. Or even worse, stopped paying dividends all together! This would easily give off a red flag sign that they’re desperate and likely strapped for cash (and don't wanna run me my money)! Not a good sign.
But on the contrary, because companies know that decreasing dividends are a negative sign and could adversely effect their stock price, they may decide to consistently pay out dividends anyway. But what if the company continues to pay out cash even if they aren’t maintaining a consistent profit? This could have significant impact on the future state of the company's financial profile and the stock could lose value later down the road — also, not a good look. So if you care to do the research, dividends can be useful for you!
Tax treatment.
For more sophisticated investors it‘s very important to understand the tax implications of your investments. You should always know the true return (net of fees, after-tax, inflation-adjusted) on your investment. If you are not using tax-deferred investment vehicles, like retirement accounts, then taxes are likely the biggest factor subtracting from your return. Dividends are taxed the same as your ordinary income — so that's at least 22% cut to your profit to pay the tax bill (but if you're on the heftier side of the salary scale, that bill is going to run you closer to 35%). However, with the new 2018 tax reform, capital gains have a more favorable treatment, at just 15% gains. After doing the tax math, this makes dividends lose even more of their luster. So for the people in the back... if you make $2000 from dividends, the real after-tax profit is closer to $1400, but if you instead had $2000 in Capital gains from trading stocks, you'll take home $1700. Which one would you choose?
ALL in ALL....
Whether or not you actually care about dividends is definitely up to you. But you should at least be aware of how much (or how little I should say) they impact your portfolio. For the average novice millennial investor, I highly doubt you will be turned on by your dividend return. So don't put too much focus into the monetary amount. You won't be disappointed if you expectation levels are set correctly!
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**Let's start with the basics: A dividend is an amount of money paid regularly by a company to its owners. You ( as a stock holder) have ownership in the company, and a dividend can be viewed as distribution of your share of the company's profits. Most dividends are paid quarterly or annually and tend to not vary in amount. See, basic right?
**Also important to note that :
Historically dividends paid a much better return. A few decades ago, the average dividend yield was 5%, so that's why our parents' generation put so much focus on their dividend income. Today's investors are only getting the mere 2% scraps. If you still haven't got the message I'm blasted all over this blog, here it is again: WE ARE NOT THE SAME INVESTORS AS OUR PARENTS. So act accordingly!
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