“Kids these days…”
You know you’re getting old when you hear those words come out of your mouth.
As the father of seven, I find myself muttering phrases like this all the time. Next, I’ll probably be yelling at the neighbors to get off my lawn!
I started thinking about my age this week when I got an email from one of your fellow Rich Retirement Letter members.
Kevin had a question about dividend stocks and whether they make sense for a young investor like him.
Today, I want to answer Kevin’s question and help you make sure that you’re investing in a way that gives you the best returns for your savings!
The False Assumption That Kills Young Retirement Accounts
Sometimes I have to shake my head at the false assumptions some investors make about stocks.
In some cases, these assumptions come from professionals who should know better!
For example, there’s a perception that dividend stocks only make sense for older investors who need income and not for young investors who aren’t retired.
That’s probably the assumption Kevin was working with when he sent me this question:
“I’m 38 and recently started investing for retirement. Should I be investing in dividend stocks now? Or should I only transition to dividends when I get closer to retirement?”
It’s a good question, Kevin. And I think it will help many of our Rich Retirement Letter members.
Of course, I can’t give Kevin any personalized investment advice. But I can share some important information that will help you invest well ahead of your retirement.
Let’s start with the assumption that many young investors have about dividend stocks.
As a general rule, dividends are paid by mature companies with reliable profits.
It’s great for retirees to invest in these stocks and have payments come in each quarter. The payments can help to fund day-to-day expenses.
But since these companies are mature, many investors expect to get lower returns over time.
After all, the real opportunities come from younger companies with more growth potential — right?
This is the reason so many young investors bypass dividend stocks and focus on more speculative areas like technology stocks.
They don’t need the income (yet) to fund retirement and they want to grow their wealth more quickly.
But that’s not always how things work!
A Candid Look at Actual Dividend Stock Returns
After reading Kevin’s email, my team and I did some research on the difference between dividend stocks and growth stocks.
You might be surprised to find out that the total return for dividend stocks is much stronger than most people realize!
Over the past 30 years, large-cap dividend stocks in the S&P 500 gave investors an average return of 11.2%. This is just barely below the 11.6% returned by large-cap stocks that didn’t pay a dividend.
But if you look at small-cap and mid-cap stocks, the roles switch. For these stocks, the average total return for dividend stocks is 11.1%. That compares very well to the average return of 9.9% for non-dividend paying stocks.
The real takeaway here is that in most areas of the market, dividend stocks perform just as well over the long term.
And we can make a strong case that these stocks carry less risk than companies that don’t pay a dividend.
After all, these stocks represent companies that are operating profitable businesses with enough cash left over to pay investors.
So these typically aren’t the kinds of stocks that are at risk of sharp losses.
Balancing Growth With Reliability
Like most areas of investing, the key to success here is balance.
Young investors and retirees alike can benefit from having a balance of dividend stocks as well as more speculative growth opportunities.
The beauty of this approach is that you can profit from growth stocks when the overall economy is growing.
And you can also benefit from the stability of dividend stocks when the markets are facing more challenges.
One suggestion I have for investors like Kevin who don’t need the income is to use a dividend reinvestment plan (or DRIP). DRIPs automatically take the dividends you receive and invest them in new shares of your stock.
In most cases, these plans are available through your brokerage account at little or no cost.
And these plans can even invest fractional shares. So for example, you can own 15.35 shares instead of waiting until you have enough cash from dividends to buy a whole share.
By using a DRIP with a more stable dividend stock, you might not see the price of your shares rise from $25 to $2,500 over the years.
But instead, you might see your position rise from 10 shares to 100 shares (or more) as your dividends continue to purchase more shares in your account.
So if you’re one of the younger members of Rich Retirement Letter or you’re worried about missing out on growth opportunities, remember that dividend stocks give you very competitive returns and can be great tools for growing your wealth — even if you don’t need the income.