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Money managers often wax rhapsodic about dividends, and with good reason: Over time, dividends account for about one-third of stock returns. Retirees should be equally enthusiastic about dividends, and not just because of the bump they give to total return: A healthy dividend yield can also make for a nice stream of retirement income.
Long-term payoffs
Dividends are cash payouts from corporations to shareholders and, if you reinvest those dividends in additional shares, the long-term payoff is amazing. For example, a $10,000 investment in the Standard & Poor's (S&P) 500 stock index 30 years ago would be worth $90,782 as of the end of November 2019. Had you reinvested dividends over that time, you'd be sitting on $171,661, according to investment tracker Morningstar. The S&P 500 is made up of America's largest publicly traded companies.
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Dividends have other charms
First, many companies raise their dividends annually, even if it's only by a small amount. You'll never get that from a bank certificate of deposit, or from most bonds.
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According to S&P, 57 members of the S&P 500, dubbed the Dividend Aristocrats, have raised their dividends every year for the past 25 years — or more. The Aristocrats include familiar companies such as 3M (61 consecutive years of dividend hikes), Coca-Cola (57 years) and Colgate-Palmolive (57 years). In the past decade, the Aristocrats have gained an average 14.78 percent a year, compared with 13.66 percent for the S&P 500.
A company that raises its dividend is signaling that it's confident it has the cash and earnings to continue to pay it. While dividend cuts aren't unknown — we're looking at you, General Electric — Wall Street looks at a dividend cut the same way Dracula looks at the sunrise. When a company cuts its dividend, its share price usually goes with it, and no CEO likes that.
The other charm of dividends? Most dividends are taxed at a lower rate than ordinary income. The tax rate for so-called qualified dividends — your brokerage can help you determine which dividends are qualified for the lower tax treatment — ranges from zero to 20 percent. (High earners with significant investment income can also face an additional 3.8 percent net investment income tax that went into effect in 2013.) A simple example: If you were to get $10,000 of taxable income and you were in the top 37 percent tax bracket, you'd hand over $3,700 to the federal government. If you got $10,000 from qualified dividends, your tax bill would fall to $2,380 — a savings of $1,320 — based on the 20 percent tax rate plus the 3.8 percent tax on high earners.
