A Gift for Your Portfolio: Dividend Stocks

‘Tis the season for gifting.

That got us thinking about some of the biggest gift givers in the market: dividend stocks.

In 2020, dividend payers struggled to keep up with the market rebound as investors leaned into the tech sector to act as the defensive part of their portfolios.

Now, as we all look to 2021 for clearer skies and a return to a life that is closer to normal, playing it safe is likely not top of mind for most investors.

Hear us out: it may be time to consider self-gifting dividends to your portfolio. They might not be the most glamorous gift (or part of your portfolio). But like that old reliable cardigan, dividends are often the gift that can keep on giving.

Dividends are a regular payment of a company’s earnings to investors based on the number of shares they’re holding. Consider it a “thank you” gift of cash just for owning a stock.

COVID and Dividends

Dividends have been a common practice among more established companies with stable profits and ample cash. About 76% of all S&P 500 companies pay a regular cash dividend. There’s even a group of S&P 500 stocks, dubbed the “dividend aristocrats”, known for their long history of paying and raising their dividends. The club includes household names like Walmart, Johnson & Johnson and Coca-Cola.

Want to keep track of which companies are changing their dividends? Check out our corporate actions article, which is updated every Friday.

Investors have been worried about the future for dividends because of the impact on profits from COVID. Paying a dividend is an expensive promise to keep, and in hard times, companies tend to cut dividends to save money. By our count, 31 S&P 500 companies (or about 6% of the index) have suspended their dividends entirely this year. Understandably, many of these companies are the ones that have been hit hardest by COVID – hotels, airlines, and cruise stocks.

The fear of more cuts has caused investors to avoid dividend payers in a period when they would’ve normally flocked to this steady eddy style of investing. In fact, the S&P 500’s dividend aristocrats have lagged the S&P 500 by 9 percentage points year to date.

Timing Opportunity

Timing is everything when it comes to investing, and there is reason to believe this could be an ideal time to consider dividend payers.

In the past, dividend stocks have shined in the early stages of an economic recovery. After the last three economic recessions, the S&P 500’s dividend aristocrats outperformed the broader market by at least 4 percentage points in the first year of each recovery.

Dividend-paying companies are usually seen as more stable and sensitive to economic changes, so they tend to lead when the economy rebounds after a rough period. Yet dividend stocks have barely kept pace with the S&P 500 since the end of June, around the time the economy began to pick back up.

Fast forward to November, and holiday cheer has shifted to the dividend payers. The dividend aristocrats jumped 12%, their best month since April 2009. The market may finally be realizing that the worst of the dividend-slashing is behind us. Some retailers recently reinstated their dividends in a vote of confidence about their future profitability. Other mega-cap companies like Microsoft, Visa and McDonald’s have even raised their dividends this year.

There are also dividend-focused stocks benefitting from the emergence of a “reopening trade,” like industrials, materials and financials. Banks are rising on speculation they’ll once again be able to raise their dividends in 2021 after restrictions were put in place by the Federal Reserve earlier this year. Together, the three sectors account for 48% of the dividend aristocrats.

There seems to be room for dividend stocks to catch up to the rest of the market, too, considering they’re down so much year to date.

Your Portfolio

There could be a role for dividends in your portfolio, too.

Dividend aristocrats have a solid track record of outperforming the market over long periods of time. And they’ve been able to beat the market with less volatility. That’s in large part because of their commitment to paying a dividend, as well as increasing that dividend annually.

Dividends can make a big difference over time, thanks to a little thing called compounding. Take the dividend aristocrats for example: they’ve risen 695% (10.4% annually) since the beginning of 2000 when you include dividend payments. Strip out the dividends, and they’ve only climbed 359% (8.6% annually) over that same period. When you re-invest dividends, they can add up exponentially.

Dividends may also be a better deal than looking elsewhere for yield. The dividend aristocrats’ average dividend yield is 2.6%, a noticeably higher payout than the 0.9% yield on the 10-year Treasury bond. Like we mentioned above, that extra income can add up over time.

The Bottom Line

Don’t overlook the dividend stocks. They may have been the market underdogs this year, but a comeback may already be brewing.

Even if you’re not a believer, it’s smart to incorporate some dividend stocks into your portfolio. Dividend stocks can provide a good mix of growth and income for your investments, while providing some stability in case there is a hiccup in the economy.

Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo-advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.

Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.