Dividend Income

What is a dividend and what should I do with dividends in my portfolio?

By Financial Advisor Carrie McDonnell

"We all hope for capital gains, but the only thing we can really count on is the dividend."
~ Warren Buffett

When you buy a stock, you become a shareholder in that company. A dividend is the distribution of a company’s earnings to its shareholders, a gift of sorts for their investors. It’s typically paid in cash (though sometimes additional stock) and often distributed quarterly. Dividend income plays a critical role in how your investments perform over time.

Dividends, in comparison to stock market prices, are generally very stable. Companies do not like to skip dividend payments or reduce dividend payments, even in the face of a volatile economy; to do so might make investors question the stability of the company. As a result, dividends tend to be regular, reliable sources of income for investors. In fact, when looking at the S&P 500 per-share dividends by year from 1960 to 2022, dividends increased in 56 years and decreased in only 6 of those years!¹

Larger, established companies with predictable profits are often the best dividend payers and the following industry sectors maintain a regular record of dividend payments:

• Basic materials
• Oil and gas
• Banks and finance
• Healthcare and pharmaceuticals
• Utilities

Startups, such as those in the technology or biotech sectors, may not offer regular dividends since these companies are often in the early stages of development and retain their earnings for research, business expansion, and operational activities.

As an investor, what you do with dividends matters. Strategically reinvesting dividend income can play a significant role in the compounding long-term return of your investment. Assuming you have a diversified portfolio, investors should prioritize using cash dividends to rebalance or reestablish the target proportions of the funds within your portfolio on a regular basis.

At retirement, however, most investors will have cash needs. If other sources of income —Social Security, required minimum distributions (RMDs) from retirement accounts and pensions—aren’t sufficient to cover your cost of living, you may need to draw down your dividend income rather than reinvest it. At this point, it’s helpful to think about your market investments as a business, wherein the shares you own are producing revenue in the form of dividends and interest. As with any business, you want your cash flow to be positive - revenue exceeding expenditures. In short, if you can limit withdrawals to just the investment income without eating into your principal, these shares should continue to produce income for many years to come.

1. https://media.onedayinjuly.com/media/pdf/2023-4_Dividends_Talking_Points.pdf