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There’s something to be said for the reliability and stability of regular dividends—those quarterly payments that allow profitable companies to reward loyal shareholders. 

While stock prices can often be volatile, old-school dividend payments can provide a steady stream of income. And, when dividends are re-invested, the potential rewards can be compounded.

The relative importance of dividends to overall returns has waxed and waned through the years. In the 1970s, dividends accounted for 73% of the total returns of the S&P 500 Index.1 In the last 10 years, they accounted for only 17% (see FIGURE 1). As the post-COVID-19 economic recovery gathers steam, dividends as a percentage of total returns have been slowly making a comeback.

 

FIGURE 1

Dividends' Contribution to Total Return Varies By Decade

Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. 
* Total return for the S&P 500 Index was negative for the 2000s. Dividends provided a 1.8% annualized return over the decade. For illustrative purposes only. Data Sources: Morningstar and Hartford Funds, 12/21.

But, even as the world of zero interest rates appears to be ending—the US Federal Reserve (Fed) is now hiking short-term rates to tame inflation—dividend-paying stocks may still be worth a closer look. Here are three reasons why: 

 

Reason 1: Income and Growth Potential

Bonds, once regarded as reliable sources of income, have struggled to pay investors any kind of meaningful yields, particularly during the two years in which the Fed held rates to near zero to combat the COVID-19 economic collapse. But even though rates are poised to rise in the coming year, they may still be sitting at historically low levels by the end of the year while profitable companies could be poised to grow their dividends.

That's because companies have been sitting on all-time high amounts of cash. As the economy begins to shift away from its COVID-19 emergency stance, increasing or initiating a dividend is likely to become a common use for corporate cash. It’s far from clear whether the expected rise in fixed-income rates can compete with the growth potential that steady dividend payers can provide. Furthermore, the recent success of cyclical- and value-oriented stocks has demonstrated a strong belief that there’s room for growth for undervalued dividend-paying companies with strong balance sheets and deep cash reserves.

 

Reason 2: Consistency Has Historically Been Rewarded

Recent research shows that companies that offer steady sustainable dividends without going overboard on payouts have provided the best returns over time.

The study, by Wellington Management,2 divided dividend-paying companies into quintiles, then ranked them from highest to lowest level of payouts. The companies that outperformed the S&P 500 Index landed, surprisingly, in the second-highest rather than highest quintile. That’s right: the “high” beat the “highest.”

This counterintuitive result suggests that some companies were making “excessive” dividend payouts and leaving themselves with less money to invest in future growth, while companies with more moderate payouts were re-investing their earnings and still retaining enough flexibility to pay steady dividends for the long term.

 

Reason 3: Dividend Growth—A Sign of Good Management

In another recent study, Ned Davis Research3 looked at dividends from the vantage point of corporate behavior. The study asked: Since 1972, what kind of company had the highest returns and lowest volatility over time: Companies that grew their dividends? Companies that cut or eliminated them? Companies that stood pat? Or companies that didn’t pay anything at all?

The results showed that companies that grew or initiated a dividend experienced the highest returns relative to other stocks—with significantly less volatility.

The study also noted a strong correlation between corporations that consistently grow their dividends and those with strong fundamentals, solid business plans, and a deep commitment to their shareholders.

Bottom line: Although they’ve gone in and out of favor throughout the years, dividends are once again showing they can still play an important role in providing income and growth potential, especially in today’s volatile environment.

Talk to your financial professional about the benefits of incorporating dividend-paying stocks into your portfolio.

 

1 S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks. Indices are unmanaged and not available for direct investment.

2 Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. The second-quintile stocks outperformed the S&P 500 Index seven out of the nine time periods (1930 to 2021), or 77.8% of the time, while first-quintile stocks came in second, beating the Index 66.7% of the time. Fourth- and fifth-quintile stocks lagged behind by a significant margin. Sources: Wellington Management and Hartford Funds, 12/21.

3 Dividend policies used in the study are for stocks in the S&P 500 Index. Sources: Ned Davis Research and Hartford Funds, 12/21.

Important Risks: Investing involves risk, including the possible loss of principal. • For dividend-paying stocks, dividends are not guaranteed and may decrease without notice. Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall.

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