Saturday, January 19, 2008

Why dividends matter?

Jonathan from MyMoneyBlog had a pretty good article about why Dow Jones Industrials is not an accurate index to follow. He sites this research paper named The Dow Jones Industrial Average: The Impact of Fixing Its Flaws. Basically this paper shows that if dividends were included in the Dow Jones Industrials, its value would be around 250,000 points in 2000, versus the 9,000 it was trading in 1999!

It is commonly known that it took the market 25 years to recover from its 1929 peak and the Great Depression. However the inclusion of dividends in the index mitigates the effects of the Great Depression. A new all-time high is reached in January 1945 instead of November 1954 if dividends are included.

To summarize, dividends should be considered an important part of ones portfolio. Financial advisers normally tell you that when you retire, you would be taking a 4% withdrawal rate from your nest egg each year. However, if you can achieve at least a 4% yield, that grows each year to at least cover the rise in inflation you would be able to weather any short-term and long-term weakness in the stock market. I would not recommend having a huge portion of your long-term portfolio in bonds, which are normally sold to retirees as a "safe and reliable source of income". You do get a fixed payment every period or so, but the purchasing power of this payment declines over time. Thus a very good strategy over the long run is to create a diversified portfolio of stocks, that have shows consistency in raising their dividends year after year and which spot an attractive dividend yield.

  • I believe dividends matter, because companies that pay regular dividends tend to be in better financial health and produce sustained earnings and revenue growth. 
  • Dividends also help identify well-managed companies; every dividend declaration represents a promise by management and a vote of confidence by the board of directors in the company's leadership. 
  • Companies that consistently raise their dividend payouts also raise the bar on their own performance expectations.
  • Shares of dividend-paying companies possess built-in value that makes them generally more resilient in down markets, with solid appreciation potential during earnings-driven market upturns — with less price volatility.

Relevant Articles:

- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates

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