I believe that dividend stocks can be worthwhile investments for investors of all risk tolerances and time horizons. These companies add stability to what could be an otherwise volatile portfolio. And, they give more certain returns in the face of unrealized losses for bear markets. Some of the best dividend stocks are also relatively stress-free investments as a result of being world-class brands such as Exxon (NYSE:MOB) or Johnson & Johnson (NYSE:JNJ).
However, beyond the obvious, let’s explore more compelling reasons that dividend stocks should be part of every investor’s portfolio.
Percentages and losses
Dividend stocks are sometimes grouped as ‘low-beta’ stocks. Therefore, they are generally less correlated with the broader market. So, during market downturns and tough economic conditions, the risk of capital depreciation is reduced.
First, dividend stocks represent generally mature businesses with large market caps. This provides resilience for both their earnings and stock price. A large market downswing might completely wipe out the valuation of a penny or speculative growth stock. But it may only leave a dent in valuation of an established consumer staples company like Procter & Gamble (NYSE:PG).
Further, the effect of losses in a portfolio is asymmetrical. If your portfolio loses 50% of its value, you need a 100% gain to get back to break even. So, losses reduce the amount of total working capital. Additionally, a volatile stock portfolio that has bigger and more frequent downswings than upswings can theoretically track to $0. And, this can make volatility destructive for building long-term wealth.
Dividend stocks, less volatile and loss-prone, can offset risk by losing less when the rest of the market sees red.
Dividends and total returns
2023 was an outlier year for the S&P 500 with the Majestic Seven stocks cumulatively contributing 54% to the index’s total return. It’s unusual that only a handful of stocks would contribute so much growth to the index.
It’s also atypical because, over long periods, dividends have contributed close to equal or the majority of returns to this index as capital gains. This is underscored by a white paper published by Hartford Funds, stating the following.
“Dividends have played a significant role in the returns investors have received during the past 50 years. Going back to 1960, 69% of the total return of the S&P 500 Index can be attributed to reinvested dividends and the power of compounding.”
The paper went on to say that dividends continue to play a strong part in the index’s return over even longer periods.
“Looking at average stock performance over a longer time frame provides a more granular perspective. From 1930–2022, dividend income’s contribution to the total return of the S&P 500 Index averaged 41%.”
When a stock portfolio is built with dividend growth in mind, the compounding effect can be a monster over time. So, this is another key reason that investors should rely on dividend stocks.
Fallacy of the Enduring Bull Market
Finally, blue-chip dividend stocks are essential because the continued growth of the stock market is far from guaranteed. It’s extremely possible that the broader market could enter into a “lost decade” scenario where capital growth is minimal or non-existent. This exact situation has happened three times between 1970 and 2000 alone.
I think it’s important to realize that many investors alive today have ever invested in only one or two of the largest bull markets in history. Those periods range from 1987 to 2000 and March 2009 to the present. Therefore, it could be natural to believe that the growth of the market is almost assured.
However, many unknown unknowns could put a stop to the assumed near-infinite growth of equities. Namely, how far can the valuation of growth companies be stretched before they become too rich for the market’s taste? Also, asset bubble collapses, black swan events, and geopolitical conflicts, among many others, could throw a serious spanner in the face of investor optimism.
Finally, simple market math could work against it. Over long periods of time, regression to the mean can be a reasonable assumption to hold. The S&P 500 trades at around 140% above its long-term trend. And, it has always eventually regressed back to its trend line over time. Currently, it sits at nearly three standard deviations above it.
Dividend stocks would give investors a buffer against a significant downturn if the S&P 500 follows a similar pattern of regression back toward it mean price. And that, along with churning over returns to investors during lost decades, makes them valuable and reliable.
On the date of publication, Matthew Farley did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.