If the stock market has been anything in February, it has been volatile and stressful. The Dow Jones Industrial Average trades down 500 points one day, it trades up 500 points the next.
And where has all this market volatility taken us? To break-even.
So, let’s rid our lives of market volatility. Let’s tamp down volatility. Let’s tamp it down with dividend stocks – the right dividend stocks.
I’m a Chartered Financial Analyst (CFA), a designation bestowed by the CFA Institute. I say that not to impress, but to inform.
As a CFA charterholder, I’m privy to investment data and analysis unavailable to the public. I’m privy to a lot of data and analysis on dividend stocks.
The Volatility Factor
To wit, dividend stocks reduce portfolio volatility in ways few investors know. Better yet, dividend stocks reduce portfolio volatility as they increase investment returns. The best of both worlds is on offer.
I turn to data and analysis provided by the CFA Institute to back my assertion. An article titled “What Difference Do Dividends Make?” was featured in the November/December 2016 issue of the Financial Analysts Journal.
I’ll cut to the chase: Dividends make a lot of difference. What’s more, the differences are nearly all positive.
The article’s authors – C. Mitchell Conover, Gerald R Jensen, and Marc W. Simpson – examined stock data from 1962 to 2014. The authors segregated stocks into four categories by average dividend yield: no yield (0% average yield), low yield (1.6% average yield), high yield (4.3%), and extreme yield (9.5%).
The authors found that the no-yield stocks – the non-dividend stocks – were the most volatile of the group. We go to the other end of the spectrum for penultimate volatility. The extreme dividend stocks – the group with the 9.5% average yield – were the next most volatile. (We shouldn’t necessarily condemn extreme yield: the group was small and it contained a number of financially distressed companies expected to eliminate their dividend.)
The low-yield dividend stocks were the third-least volatile of the categories. The high-yield stocks –the group with the 4.3% average dividend yield – were the least volatile. The high dividend payers were nearly half as volatile as the no-yield stocks.
High Dividend Payers and Higher Returns
Conover et al.’s research shows that dividend-paying stocks can reduce portfolio volatility. Their research also shows that these same stocks reduce volatility without a corresponding reduction in investment returns.
High-yield dividend stocks actually lead to higher returns.
When the authors averaged monthly returns, they found the no-yield (non-dividend payers) offered the lowest monthly return at 0.77%. The low-yield dividend payers offered the next lowest, with the average monthly return at 0.80%. The extreme group – the highest-yield stocks – did surprisingly well over time. Their average monthly return was 0.85%.
The high-yield group again provided the sweet spot. The group with the average 4.3% dividend yield produced the highest average monthly return at 0.9%.
More telling, growth-stock investors benefit when their growth stocks pay dividends.
Non-dividend-paying growth stocks were more volatile and returned less than the low-yield and high-yield groups. The Conover et al. research show that high dividend payers have the least risk, yet return over 1.5% more per year than non-dividend payers.
Most intriguing, the dividend benefits are most significant for growth and small-cap stocks, the stocks of companies usually thought to benefit the least from paying dividends. Growth investors targeting average-size or below-average-size companies could have quadrupled returns by investing in high-dividend-yield stocks rather than no-dividend stocks
By increasing dividend exposure from none to high yield, the small-cap growth category more than quadrupled its returns. Mid-cap growth stocks increased their returns roughly fourfold.
Go high yield, and go with small- and mid-cap high-yield dividend stocks first. Once on your way, toss in a few quality high-yield, large-cap dividends for good measure.