You can add income, capital appreciation, and tax advantages to your portfolio with dividend-paying stocks.
As an investor, you inevitably make tradeoffs along the way. Every time you make an investment decision, you weigh the positives and negatives of one choice relative to another. You probably chose investments that offered the potential for the income, appreciation, and tax benefits you needed to help achieve your goals. Over the long term, dividend-paying stocks (through various market conditions and volatility) have consistently delivered a number of total return benefits.
Primary Benefits
Like a Swiss Army knife that has many uses, dividend-paying stocks provide investors with four primary benefits that may alleviate recurring tradeoffs. They include:
1. Current Income That May Grow Over Time
Historically, investors have purchased equities, or stocks, which represent proportional ownership in a company, hoping their shares will appreciate in price as the company becomes more profitable. But stocks may deliver other benefits as well. As companies prosper and mature, they often share some of their profits with shareholders in the form of cash dividends, although this is not guaranteed. Like bond interest payments, cash dividends represent a current form of income. Unlike bond interest payments, which remain fixed for the life of the bond, cash dividends paid to equity shareholders may grow over time.
Source: S&P Dow Jones Indices from May 1971 to February 2025. The S&P 500 was launched on 4 March 1957, so data prior to that is back-tested hypothetical data. Past performance is no guarantee of future results. The chart is provided for illustrative purposes and reflects hypothetical historical performance.The chart above shows the magic of compounding for the S&P 500 over several time horizons, comparing simple return to a return plus dividends reinvested. The percentages are averages for every continuous horizon, based on monthly data for the over 50-year period ending at the end of February 2025. The compounding effect increased as time increased, which reveals a positive relationship between the two variables. For example, the annualized difference between the price return and the total return of the S&P 500 over every 10-year horizon, on average, amounted to 77%.
2. The Durable Participation of Income
Dividend-paying companies play a key role in the portfolio’s ability to provide both performance and protection. Dividends are a sign of a company’s earnings and cash flow strength, and they force companies to be practical with their free cash flow allocations. As shown in the graphic below, dividends have been impactful because they have comprised around half (49.3%) of the S&P 500’s total return since 1871 (on a decade-by-decade basis), with the other half consisting of price appreciation. The chart also reveals that price appreciation has been variable over time, while the income component has been relatively consistent.
Past performance does not guarantee future results. Source: Jack W. Wilson and Charles P. Jones, “An Analysis of the S&P 500 Index and Cowles’s Extensions: Price Indexes and Stock Returns, 1870–1999”, Journal of Business, 2002, vol. 75 no 3. Data after 1990 is from Bloomberg, Confluence, and FactSet. Calculated by Thornburg Investment Management. Returns are annualized.3. Downside Protection
With global markets becoming increasingly volatile, a steady infusion of income in the form of high-quality, dividend-paying securities can be a foundational element of a risk-aware portfolio. Dividends can provide a cushion during down-market months and have been an essential component of total return in other periods. Securities with sustainable dividends are the most predictable part of the return and provide a consistent flow of income for investors.
Source: S&P Dow Jones Indices LLC. Data from 31 December 1999 to 30 September 2024. The S&P HYDA (High Yield Dividend Aristocrats) was launched on 9 November 2005. All data before the index launch date is back-tested hypothetical data. Past performance is no guarantee of future results. The chart is provided for illustrative purposes and reflects hypothetical historical performance.4. Potential Tax-Advantaged Income
Finally, according to the United States Internal Revenue Code, cash dividends investors receive from equities may qualify to receive tax-advantaged treatment. As a result, ordinary cash dividends paid to shareholders that meet specific criteria may be taxed at the lower long-term capital gains tax rate rather than at the higher rate that’s applied to an individual’s ordinary income. It should be noted that everyone’s tax situation is different, and this should not be considered tax advice. You should consult your tax advisor for personal tax concerns.
Key Takeaway
Dividend-paying stocks are a versatile investment that you may have previously overlooked. Combining the power of dividends with an active approach can serve to help meet short-term funding needs, such as retirement income or foundation distributions, and contribute significantly to long-term growth to make a future income stream last.
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