Dividends are the gift that keeps on giving, but not every investor is eager to buy in. According to a TD Ameritrade report, millennials largely steer away from dividend stocks, preferring to hold non-dividend tech offerings long term instead.
This growth-focused mindset may explain why younger investors generally avoid dividend stocks, says Dave Geibel, senior vice president and managing director at Univest Wealth Management in Souderton, Pennsylvania. “Most dividend stocks tend to be value-oriented companies, which may not fall in line with the companies millennials are in tune with,” he says.
[See: 10 Dividend Stocks Boasting 100 Years of Payouts.]
Geibel says there’s often an assumption that dividend-paying companies are old-fashioned and not growth-oriented. He cites companies in the Standard & Poor’s 500 index, of which more than 400 in virtually every sector currently pay a dividend to shareholders. “Dividend-paying stocks aren’t always boring companies with no growth,” Geibel says.
For instance, the S&P 500 stock that pays the largest dividend — Apple ( AAPL) — is the same one that ranks as a millennial investing favorite, according to TD Ameritrade, suggesting that young investors aren’t counting out dividend stocks completely. In May 2017, Apple announced a 10.5 percent increase in its dividend payout to $13.22 billion annually. If you’re a young investor with a penchant for high-growth tech companies, you may not be fully sold on the idea of dividend stocks, but there are some good reasons to reconsider.
Stable returns, lower volatility. Growth stocks tend to see their performance driven by market movements, making them more volatile than staid dividend counterparts. The stability that dividend stocks offer is not something millennials should take for granted, however. “One of the attractive aspects of a dividend stock is that regardless of how the stock performs, the investor can rely on receiving a regular payment,” says John Knolle, principal and financial planner at Saranap Wealth Advisors in Walnut Creek, California. He says that while value stocks may not be as sexy as growth stocks, they thrive long term.
Between 1990 and 2015, for example, dividend stocks outperformed their growth peers in all three market cap categories, beating small-cap stocks by 187 basis points. Better performance is only half the story, Knolle says, because “not only did dividend stocks outperform but they did so with less volatility over that same period.” On average, value stocks exhibited approximately 25 percent less volatility across small-, mid- and large-cap categories.
The reduced volatility that dividend stocks offer can be especially significant during wide market swings. “Lower volatility can be important, especially if millennials are more risk-averse than the average investor,” says Jane Barney, senior client advisor with Boston-based TFC Financial Management. “They may be less inclined to bail out of a dividend-paying stock during a market downturn if it doesn’t lose as much value as some of their growth stocks.”
Even though the first rumblings of the financial crisis were a decade ago, many millennials have yet to let their guard down when it comes to risk. According to a Legg Mason survey, 82 percent of millennials say the crisis still influences their investment decisions. Dividend stocks could hold a certain appeal for millennials who are cautious about gambling on more volatile growth stocks.
[See: 9 of the Market’s Best Growth Stocks.]
Compounded growth. Generating income is something investors typically think about as they move into their 50s and 60s. Investing in dividend stocks while you’re younger can be a a powerful way to capitalize on the benefits of time, even if you don’t necessarily need the income those stocks are generating right away.
Jack Leslie, portfolio manager of the Miller/Howard Income-Equity Fund ( MHIEX) based in Woodstock, New York, says dividends can be invested in more stock that pays more dividends every quarter, compounding your yield on an original investment over time. At the same time, you may reap the benefits of a higher dividend payout if the company’s earnings are increasing.
The longer the time frame, the greater the impact of reinvested dividends on total return. This is largely because your dividends are always buying more shares, creating a compounding dynamic. “Each share purchased at the beginning of a decade, for example, might become two to four shares by the end of the decade, depending on the level of income and the course of prices,” Leslie says.
Diversification. The key to investing strategically with dividends when you’re younger is having the right blend of value and growth. Nahum Daniels, a Stamford, Connecticut-based certified financial planner and representative of Brokers International Financial Services says millennials should allocate a very small percentage of their portfolio to dividend stocks, because “theoretically, they have a job and don’t need income from their investments.”
Millennials should be investing in companies that have long-term growth potential and holding on to that stock, Daniels says, as they have time to ride out any fluctuations. If you’re investing in dividend stocks, he advises looking at year-over-year dividend growth when choosing investments. “You want a company that pays more dividends every year,” so the increase in annual payout allows you to keep pace with inflation. He also recommends investing in mutual funds that specialize in putting dividend champions in one portfolio so you have a “cross-section of high-paying dividend companies.”
Considering how dividends fit your overall diversification strategy is important when choosing individual stocks. Geibel says it’s possible to have a balanced portfolio across all 11 sectors that includes companies with potential to grow and pay a dividend. For millennials, that means incorporating both tech stocks that pay dividends, along with more tried-and-true sectors like consumer staples and industrials.
Geibel says in addition to considering a stock’s dividend growth rate, younger investors should also look at cash flow and debt ratio to determine whether the dividend is sustainable. And it’s OK to consider companies that may not pay a dividend now but have the potential to do so later on because they have considerable cash reserves.
[See: 7 Things to Look for in Dividend Stocks.]
The important thing is to avoid developing tunnel vision regarding where dividend stocks belong in your portfolio. “Don’t target dividends for investment choices, target growth to value,” Geibel says. “You can use dividends as part of your criteria for picking a company and you’ll be balanced.”
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Millennials Should Try Dividend Stocks originally appeared on usnews.com
