Market Beat: Dividends for total return
Cash dividends are payments made by corporations to their shareholders. The board of directors of the corporation declares them, typically on a quarterly basis. They are not guaranteed. The payment is subject to change at any time. Dividends are taxable, but at a lower rate than ordinary income.
Historically, cash dividends have proven to be a very important component of total return. Total return is calculated by adding cash distributions to the price return. Having some dividend paying stocks in your portfolio can provide income and some downside protection.
In the decade of the 1930s, during the Great Depression, the price return for the market was minus 5.3 percent, while the dividend yield was a positive 5.4 percent. The cash flow from dividends offset the drop in the market.
In the decade from 2000 to 2010, the price return for the market was negative 2.7 percent, while the dividend yield was a positive 1.8 percent. In decades where the market’s price return has been very strong, dividends are not as important. In the 1990s, the market’s price return was 15.3 percent and the dividends were only 2.5 percent, that’s according to a study by J.P. Morgan.
Standard and Poor’s has an index known as the Dividend Aristocrats. The equities that make up the Dividend Aristocrats are selected by their history of paying a dividend consistently and increasing that dividend over time. Over the last 10 years, the S&P 500 has averaged a return of 9.46 percent per year, while the S&P Dividend Aristocrats have averaged 12.94 percent. Those are total return numbers from Standard and Poor’s. Over the last year, which has been a very strong year for the market, the S&P 500 has returned 25.19 percent and the Dividend Aristocrats have returned 24.16 percent.
Companies that have a good dividend history are normally well-established corporations with good cash flow.
Dividends can provide some decent income in this low interest rate environment and also give a little downside buffer to the inevitable market corrections and bear markets that occur periodically.
Over a long period of time, dividends can reduce your cost basis on your purchases. Dividend paying stocks can also be combined with covered calls to provide additional income and additional yet limited downside protection in the event of a market decline. There have been numerous academic studies done that show that writing covered calls can enhance returns and lower portfolio volatility.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.