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Why dividend growth is important for young workers

Originally published on Marketwatch.com’s website http://www.marketwatch.com/story/why-dividend-growth-is-important-for-young-workers-2015-01-09?dist=countdown

Young people entering the workforce should start contributing to their retirement plans as soon as possible. They need to invest early and save frequently. When investing in stocks, it’s important to understand the role that cash dividends play.

Over long time frames, dividends have been responsible for more than 40% of the total return of some of the major indexes.

Dividend paying stocks also tend to be good performers. Standard & Poor’s has an index known as the S&P 500 Dividend Aristocrats SPDAUDP, -0.78% The stocks in the index are selected by evaluating their history of paying and increasing dividends. The Dividend Aristocrats have beaten the S&P 500 over the last several years.

According to S&P Indices, as of Dec. 31, 2014, the Dividend Aristocrats have outperformed the S&P 500 as follows;

Three Years Five Years 10 Years
S&P 500 Index 20.41% 15.45% 7.67%
Dividend Aristocrats 21.43% 18.28% 10.55%

Young people in the accumulation phase of their retirement planning should consider the effect of rising dividends.

Say you purchase a stock or a fund today with a dividend yield of 2% and you plan to hold it long term. Of course you want that investment to increase in value over time, but what happens if the cash dividend increases as well? Down the road you could be holding an investment that has a fairly high yield relative to your initial cost. That yield could very well double or triple over a long holding period, meaning that in the future your yield to cost could grow to 4% to 8% or even more.

Let’s take a look at investing in the Dow Jones Industrial Average DJIA, -0.72% It’s not possible to invest directly in the index, so we’ll consider the ETF that represents the Dow, the SPDR Dow Jones Industrial Average ETF Trust, or Dow Diamonds DIA, -0.66%  for short. Assume that you purchased one share of DIA on Jan. 20, 1998 for $77.81. At the end of 1999, your first full year owning the fund, you’d have collected $1.53 in dividends for a realized yield of 1.98%.

As of Dec. 26, 2014, over a period of about 17 years, you would have collected $40.96 in dividends, which means that over 50% of your initial investment would have been returned to you in cash payments. For the calendar year 2014, you would have collected $3.45 in dividends. So, your realized dividend yield for 2014 based on your original investment of $77.81 would have been 4.44%.

The important concept here is that in your 17-year holding period, while the price of the fund has more than doubled, so has your dividend yield. Your dividend yield has increased from less than 2% to more than 4%. Dividend growth can affect your future income stream in a very profound way.

DISCLOSURE: Clients of Kenneth Roberts are invested in DIA

Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.

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