How to build up your bets – and returns – in dividend-paying stocks
Dividend stocks could be poised to get their moment in the sun as interest rates fall – and investors only need to take a simple step to boost their long-term returns in these positions. The Federal Reserve kicked off its rate-cutting campaign in September with a half-point reduction, and central bank policymakers projected that rates would come down by another half point by the end of the year. Investors who have been socking cash away in money market funds – which have already seen their yields slide since the summer – might be inclined to snap up dividend stocks as they search for income. “We saw this rapid increase in rates and lots of flows into short-term cash instruments and money market funds where people were getting safe returns that were sometimes in excess of 5%,” said Dan Stein, a certified financial planner and branch manager of Charles Schwab in Tysons Corner, Virginia. “As rates fall, we might see people looking for longer-term alternatives and, in turn, dividend-paying stocks,” he said. That’s where dividend reinvestment plans, or DRIPs, come into play. Taking bites of the apple Rather than receiving a cash payment when your favorite stock pays its dividend, you can elect to have your broker reinvest the dividend. This way, the money is used to buy shares, growing your position in the stock over time. There are a few advantages to so-called DRIPs. For starters, it’s a form of dollar-cost averaging into a position, meaning you’re buying the stock at regular intervals regardless of the price. “This is a great opportunity for investors to take ‘bites of the apple’ every time a dividend is paid,” said Jay Spector, CFP and co-CEO of EverVest Financial in Scottsdale, Arizona. “It allows them to reinvest this dividend on a regular scheduled timeframe and have a great opportunity for a larger total return over the long term.” Indeed, the most attractive feature of dividend reinvesting plans is the ease of compounding returns over time – of course, assuming you went with a name that has a steady record of paying dividends. Consider International Business Machines , a so-called dividend aristocrat with a long track record of raising its payment annually for at least 25 years. If you bought $1,000 of IBM stock in 2004 and held the position for 20 years, you’d have $3,788 if you just pocketed the dividend payment. That’s a return of some 279%. But if you used the dividend to buy more shares of IBM, you’d wind up today with $5,178 at the end of the 20-year period, for a total return of about 418%. The tech giant is up 41% in 2024 and offers a dividend yield of 2.9%. Retailer Target Corp is another case study of how investors can be rewarded over the long run if they reinvest dividends. The stock is up nearly 10% in 2024 and also offers a dividend yield of 2.9%. An investor who bought $1,000 in Target shares 20 years ago and received the dividend in cash would’ve seen a return of 322% in that period, or an end value of $4,221. By redeploying the money into the purchase of more shares, that same investor would’ve seen a total return of 429%, or a value of $5,288, at the end of the period. There are inherent risks to dividend investing, of course. Dividend yields that are very high could suggest that the company’s stock price has been falling. Further, a company suffering through hard times can be tempted to slash dividend payments in a bid to conserve cash. For investors who’d rather simplify and diversify their approach toward dividend payers, an exchange-traded fund might fit the bill. The ProShares S & P 500 Dividend Aristocrats (NOBL) has a total return of nearly 15% in 2024 and an expense ratio of 0.35%. IBM and Target are among the holdings, along with household names including McDonald’s , Lowe’s and Clorox . If dividend growth is a priority, there’s the Vanguard Dividend Appreciation ETF (VIG) , which has an expense ratio of 0.06% and a total return of almost 20% in 2024. Constituents include major tech plays Apple , Broadcom and Microsoft , as well as UnitedHealth Group and Exxon Mobil . DRIP care and maintenance As easy as it is to “set and forget” your dividend reinvestment plan, you’ll still have to perform some regular upkeep on the position. For starters, even though you’re not receiving your dividend in cash, you’re still responsible for reporting the income to the Internal Revenue Service and paying taxes if the position is held in a taxable account. You should also take the dividend reinvestment plan into consideration as you rebalance your portfolio and ensure that the size of the holding is still reflective of your goals and risk appetite. “Self-directed investors have a hard time sticking to [rebalancing] and overcoming biases of not wanting to sell stocks or buy others, but having this disciplined strategy is something to consider when you have dividend reinvesting and you’re seeing these positions grow,” said Stein at Charles Schwab. –CNBC’s Chris Hayes contributed reporting.
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