Many investors, like you perhaps, already recognise the huge importance that dividends pay in boosting your portfolios and self-managed super funds' returns, so I'm probably preaching to the converted.
A basic explanation is that dividends represent one part of the returns investors can receive from owning company shares – the other is obviously capital gains.
Over the long term, several studies have shown that dividends can make up as much, if not more than half the long-term return – but that's not the whole story.
There are other benefits associated with companies that pay dividends, including these three…
- According to noted US fund manager Tweedy Browne, evidence (PDF) suggests that portfolios consisting of higher yielding stocks can produce returns above those of lower-yielding portfolios and overall stock market returns over long periods.
- Stocks with high and sustainable dividend yields can be more resistant to price declines because the stock is 'yield supported'.
- The ability to pay cash dividends is a positive factor in assessing the underlying health of a company and the quality of its earnings.
Research has shown that over 101 years from 1900 to 2000, a portfolio with dividends reinvested would have generated nearly 85 times the wealth generated by the same portfolio relying solely on capital gains.
Professor Jeremy Siegel also showed that reinvesting dividends during stock market declines can dramatically lessen the time necessary to recoup portfolio losses.
And a study of the top 1,000 US stocks from 1970 to 2005 has shown that the highest dividend yield stocks even had lower risk than their low-yield counterparts.
The fourth reason dividend stocks are important is this. Australian dividends come with a big bonus – and that's franking credits. Essentially it means that companies have already paid tax on their earnings – which are paid out to shareholders as dividends. To avoid double taxation, the ATO allows investors to claim a tax benefit for the franking credits attached to dividends – thereby boosting returns.
Clearly then, dividends represent an important consideration when investing in ASX-listed companies. But many Australians probably haven't realised the other advantages investing in dividend paying stocks has – as listed above.
If you don't have a healthy allocation of dividend stocks in your portfolio, now might be the perfect time to consider it. More than a few of us will already have a decent chunk of their portfolios in the some or all of the big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC).
The issue is that the big four may be facing strong headwinds, which could dampen dividend yields over the next few years, so investors might want to look outside the usual suspects for dividend and income ideas.
