The Strategic Role of Dividend-Paying Stocks

For investors looking to balance income needs with long-term growth, dividend-paying stocks offer a practical way to potentially keep money working in the market and stay invested over time. The decision to take dividends as cash or reinvest them depends on what you need from your portfolio today—and what you're trying to build for tomorrow.

1. Dividend-paying stocks offer one potential way to seek income while staying invested in the long-term growth potential of the stock market.
2. Reinvesting dividends puts income back to work, giving compounding more time to potentially enhance long-term results.
3. A dividend strategy works best when it fits your goals, income needs, time horizon, and tolerance for risk, and should be considered in the context of your broader investment portfolio.

Dividends are payments companies make to shareholders, typically from earnings. They can provide cash flow along the way while investors remain invested in the stock market, and these cash flows can be paid out or reinvested. Exhibit 1 helps to illustrate these points. It compares the hypothetical growth of a $10,000 investment in the Dow Jones U.S. Dividend 100 Index over the past decade using two approaches: reinvesting dividends or taking them as cash.

In this hypothetical example, reinvesting dividends over the course of the past decade would have resulted in an ending portfolio value approximately 42% higher than taking dividends as cash. The primary reason for the difference is compounding: reinvested dividends buy additional shares, which can potentially generate additional dividends and so on, giving investors a better chance of participating in future growth.

This doesn't mean reinvesting is right for everyone. Some investors may need or want the income now, so taking dividends as cash may make sense, while still potentially providing some of the longer-term benefits that stocks have traditionally provided. However, if you have a longer time horizon and don't need the income right away, reinvesting may help you stay focused on the potential for future growth. The right choice depends on your unique situation, based on factors like your goals, time horizon, risk tolerance, and income needs.

Whether you choose to reinvest dividends or not, Exhibit 1 reminds us of the power that dividends can potentially provide over time. When consistently reinvested, dividends may become an important part of your long-term financial plan. And this point might be particularly worth keeping in mind when constantly shifting market conditions make positive returns challenging to capture.

Income is often the main reason that investors consider dividend-paying stocks, but it's not the only one. Dividend-paying companies can also potentially bring qualities that complement other equity investments and strategies.

Many companies with a history of paying dividends are established businesses with durable earnings and cash flows. For investors seeking a mix of income potential, equity exposure, and long-term growth, this can be an appealing combination.

• Income potential. Dividends can provide cash flow that investors may use for spending needs or reinvest for future growth.
• Equity exposure. Dividend-paying stocks allow investors to stay invested in the stock market, with the potential for both income and price appreciation.
• Diversification potential. Dividend-paying stocks can sit alongside growth-oriented investments as part of a diversified portfolio, helping investors access a broader mix of companies, sectors, and potential return drivers.

Dividend-paying stocks still involve risk, including the potential for share-price declines and dividend reductions. That's why they're often best considered as part of a diversified investment portfolio, not as a standalone solution.

You can invest in dividend-paying stocks through individual securities or through investment vehicles such as exchange-traded funds (ETFs), mutual funds, or separately managed accounts (SMAs). And if you'd like some help planning the right course for your financial future, consider working with a financial advisor. These professionals can help you evaluate which approach may align best with your goals, time horizon, risk tolerance, and income needs.

If dividend-paying stocks seem like a good potential fit for your needs and plans, the following steps might help you decide how they can potentially work within your broader portfolio.

1. Check in with your investment advisor or wealth manager. Discuss whether dividend-paying stocks or funds might be a good fit for your portfolio and work with your advisor to determine the right allocation for your unique situation.
2. Check your overall allocations. Consider how dividend-paying stocks would fit alongside your current mix of stocks, bonds, cash, and other investments.
3. Clarify your income needs. Decide whether you need dividends for current spending or whether reinvesting them may better support your long-term financial hopes and dreams.
4. Choose the right investment vehicle. Consider whether individual stocks, exchange-traded funds, mutual funds, or a separately managed account would best match how you would prefer to invest and the level of diversification and active involvement that might be right for your situation.
5. Look beyond yields. Higher dividend yields can be attractive, but they may also signal higher risk. Sometimes a stock has a high yield because of a falling stock price and deterioration in the fundamental outlook that could result in a dividend cut in the future. If you're considering a fund or SMA, review how the strategy selects its holdings.