Don't forget the power of dividends

by Wayne Ferbert on March 25th, 2013

It is easy to get caught up in trading strategies or tactics and forget some of the most important lessons of long-term investing. One of those important lessons is about the importance of dividends.
 
Dividends are a key part of the total return of your portfolio. In fact, studies show over the long-term that companies that pay dividends over long windows (10 years or more) tend to out-perform their peers that do not pay them. This shouldn’t be a surprising fact, really. A dividend is a return of earnings to shareholders.
 
Returning income to shareholders will always make sense. That cash can be re-deployed to your portfolio across your entire diversified approach. If the company retained it, they might not put it to as good a use as you can. In fact, over time you know these companies will have ups and downs in their stock prices that are not always caused by the company’s performance – but by wider macro issues.
 
Returning the capital to you to re-deploy in a diversified strategy is better than taking the risk that the macro issue might engulf your stock's price - or even worse that a micro issue might hurt the stock.
 
I am reminded of the importance of dividends by an ETF that is growing in popularity: the SPDR S&P Dividend ETF. It targets only the companies within the S&P 1500 that have increased dividends for every year for the last 20 years. They are called ‘dividend aristocrats’.
 
The SDY, since its inception in November 2005, has out-performed the S&P 500 by 10% on a dividend adjusted basis since that time. This is really being driven by the dividends – because on a price basis, the SDY has underperformed the SPY (S&P 500 etf) by around 4% since inception.
 
In the last year alone, the SDY has out-performed the SPY on a price basis alone by 5% - attributed mostly to the fact that dividend aristocrats tend to be financials, staples, and utilities. They do not tend to be energy or technology stocks. So, the SDY has done nicely – and even better on a dividend adjusted basis. You can see the price based chart below.
 
The SDY can be hedged using the S&P500 – as they have a correlation over 95%. So, look to hedge the SDY with either the $SPX or SPY.
 
But in the end, the dividend will always help to drive the returns up – because the return of capital to investors without a dilution in ownership (or a weakening of the business model )is nearly always a positive for the investor.


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