When Markets Rage, Do Dividends Help?
The most recent wave of October volatility has come and gone, but it offers year-round lessons for financial advisors on helping clients focus on the long term using dividend-paying stocks.
Halloween isn't the reason that most investors are nervous until October ends each year. Many will recall that 1987 had the worst October in modern stock market history when the S&P 500 plunged 21.76% during the month. And stocks have experienced four other double-digit percentage drops in the 10th month of the year -- in 1929, 1932, 1937 and 2008.
This year, the early part of October looked like it would fit that pattern, as advisors fielded calls from worried clients asking if the time had come to sell all stocks. Despite troubling news about Ebola, the Islamic State and Ukraine, once again the world didn't end, and stocks even managed to post a small gain for the month.
To get their clients through October, many advisors donned their psychologist hats and focused on the long-term benefits of investing rather than the short-term fears associated with the headlines. Over the long term, dividends can help clients to cope both materially and psychologically.
Materially, reinvested dividends have accounted for slightly more than 40% of the market's annualized total return from 1926 through June this year.
Dividends offer a psychological advantage, too: Because investors who hold dividend-paying equities can look forward to another payment within a few months, they should be more likely to maintain their positions. By contrast, those who buy a dividend-free hot stock today in hopes of quickly selling at a profit may be inclined to cut their losses as soon as the market dips.
The cumulative effect of dividends can be seen in data from S&P Dow Jones Indices. As the following table shows, the price return of the stocks in the S&P 500 from the end of December 1989 through last month was 471.04%. But over the same period, the total return of the index was 869.93%.
Market sectors that are known for their rich dividend payments, namely utilities and telecommunication services, show even greater disparity between stock price returns and total returns. But even sectors that traditionally lagged in dividends, such as technology and consumer discretionary, show a considerable difference between stock price returns and total returns over the period.
What's more, as dividends have become more desirable in a low-yield world, more companies in all sectors are paying a cash return to their shareholders.
About 70% of the stocks in the information technology sector of the S&P 500 pay a dividend. During the dot-com bubble days at the end of the last century, dividends in the sector were fairly rare.
The dot-com bubble was a typical speculative mania that long-term investors periodically have to endure.
Unfortunately, the first exposure many people have to the stock market is through speculation -- if, say, a friend or relative gives them a "can't lose" tip. It is a story that often ends badly, as it did in 2000.
Although some people never outgrow the tendency to confuse gambling and investing, others, often with an advisor's help, go on to set long-term goals and make prudent asset allocations. Dividend-paying stocks, and the mutual funds and exchange-traded funds that feature them, can help anchor equity positions with cash returns that investors can either spend or reinvest -- no matter how scary the short-term headlines are.
As Mark Twain, a technology speculator in his day, wrote 120 years ago: "October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February."
Joseph Lisanti, a Financial Planning contributing writer in New York, is a former editor-in-chief of Standard & Poor's weekly investment advisory newsletter, The Outlook.