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What Dividend Stocks Can Offer

A key element of most portfolios, they can be particularly useful when interest rates are low and markets are volatile

What Dividend Stocks Can Offer image

INVESTORS TEND TO FOLLOW the ups and downs of the stock market closely, watching—and hoping—for price gains. But many overlook another potential source of returns: the dividends that many companies can pay their shareholders.

Investors should always look at both price gains and dividend income when considering their total return, says Nick Giorgi, an investment strategist in the Chief Investment Office for Merrill and Bank of America Private Bank. But there are a couple of other reasons that make dividend-paying stocks particularly useful. First, the income they provide can help to balance losses during periods of downside volatility. And in low-interest-rate environments, they can potentially offer a higher yield than Treasurys, CDs or even corporate bonds.

Below, Giorgi offers more insights into the role that dividend-paying stocks could play in your portfolio.

What exactly are dividends—and what kinds of companies offer them?

Dividends represent a payment by a company, typically made on a quarterly basis, to its shareholders from income generated by the business. “Generally, it’s larger, more mature companies that return capital to their shareholders in the form of dividends,” Giorgi says. Smaller and growing companies tend to reinvest earnings back into their business. Dividends aren’t guaranteed, however. For instance, some dividend-paying companies have temporarily lowered or suspended dividends in response to earnings losses as a result of the coronavirus pandemic.

Text in slide 1 reads: “3 Reasons to Consider Dividend Investing. Investing involves risk. There is always the potential of losing money when you invest in securities. Past performance is no guarantee of future results.” Beside the text is an illustration of a magnifying glass reviewing a line chart.
Text in slide 2 reads: “Returns. Dividends made up 43 percent of the S&P 500’s total return from 1930 to 2018. (Source: Bank of America, “The Ins and Outs of Dividend Investing,” August 2019). Investing involves risk. There is always the potential of losing money when you invest in securities. Past performance is no guarantee of future results.” Beside the text is an illustration of a coin with an arrow in the shape of a circle around it.
Text in slide 3 reads: “Earnings. Companies that pay dividends tend to show more consistent earnings and fewer losses. (Source: Bank of America, “The Ins and Outs of Dividend Investing,” August 2019). Investing involves risk. There is always the potential of losing money when you invest in securities. Past performance is no guarantee of future results.” Beside the text is an illustration of a young plant.
Text in slide 4 reads: “Buffers. Dividend investing has helped to buffer losses for investors during periods when the S&P 500 has fallen by 5 percent or more. (Source: Bank of America, “The Ins and Outs of Dividend Investing,” August 2019). Investing involves risk. There is always the potential of losing money when you invest in securities. Past performance is no guarantee of future results.” Beside the text is an illustration of a u-shaped neck pillow.

“Companies that have consistently increased their dividends tend to be well-run businesses, which historically have weathered downturns and may have greater return potential over time.1—Nick Giorgi,
an investment strategist in the Chief Investment Office for Merrill and Bank of America Private Bank

Why should I consider adding them to my portfolio?

There are two key roles that dividend-paying investments can play: providing investors with income to help meet immediate cash needs—something that retirees might increasingly look to them for, particularly in low-interest-rate environments—and offering potential downside defense during market sell-offs. “Companies that have consistently increased their dividends tend to be well-run businesses, which historically have weathered downturns and may have greater return potential over time1,” Giorgi says.

Are there different kinds of dividend-paying stocks?

Absolutely. Some offer a higher dividend, while others issue smaller dividends that may tend to grow steadily. “One mistake to avoid,” Giorgi says, “is to buy a company’s stock simply because it issues a high dividend.” If the company has leveraged excessive debt to fund the dividend, it could come at the expense of future profitability and hurt growth prospects. Or a company may seem to offer a high dividend yield simply because it recently experienced a price decline. “Always take into account prospects for both growth and income and how they align with your particular needs and goals,” Giorgi notes.

What types of dividend stocks should I consider for my situation?

If your goal is creating an income stream, you might simply look for stocks with above-average dividend yields over a longer time period, says Giorgi. But if you’re a growth-oriented investor who isn’t looking for immediate income, consider investing in stocks that have a track record of increasing their dividends as cash flows and profits increase.

How do I get started?

Beyond individual stocks, there are numerous exchange-traded funds, index funds and mutual funds to explore. Some emphasize dividend yield; others focus on dividend growth or offer a mix of both. Still others focus on global stocks, which can provide further diversification. Many international equity indexes potentially offer higher dividend yields than U.S. indexes. “Work with your advisor to tailor your strategy to your individual needs, considering your short- and long-term goals and time horizon, as well as your risk tolerance and liquidity needs,” Giorgi says.


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