You go to the supermarket and see that your favorite French fries are 50% off. Picking up two bags for one price is a no-brainer.
Then you come home and log into your brokerage account and see that your stock is down 50% over the last year. That’s really scary, so she goes offline to wait for prices to go back up.
Investors react very differently to these two scenarios, but they are fundamentally very similar. Investors with money to invest, dividend investors in particular, should accept falling stock prices, and I’ll tell you why.
Why buy dividend stocks in the first place?
Sometimes companies have “too much money” – a great problem to have. Instead of sitting on it, they could give it to shareholders as dividends. Investors love dividends because they are actual cash earnings from the companies in which they own shares. The share price can go up or down; it doesn’t matter once you receive dividends; they are cash in your pocket.
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Too many people assume that dividend stocks are strictly for retirees or those approaching their golden years. This is because dividend stocks apparently have a reputation for being boring, slow-growing businesses that won’t generate substantial returns for investors.
However, dividends have contributed 32% of the S&P 500‘s total investment returns since 1926, according to global S&P. If you have ignored dividends, there is a greater chance that you have underperformed the index.
Why “bear markets” are great for investors with cash to invest
During a conference, the famous investor Peter Lynch once joked: “I love volatility.” There are times when the stock market will go down significantly; It has happened throughout the history of the markets and it will probably happen again in the future. Investors are in the teeth of a market crash right now!
The market is like a tide and individual stocks are like ships. When the tide is strong, almost all stocks rise in value. But when the tide goes out, all the boats sink. So when your stock goes down with the entire market, it’s usually nothing to worry about. Investors should celebrate that they can buy their favorite companies at a discount.
As long as a company has solid fundamentals, such as:
- Growing income.
- positive gains.
- A healthy balance.
- Competitive advantage over their peers.
It is very likely that the stock will continue to rise in the long term. An investor should be concerned when the stock price keeps falling when the market is thriving. He always checks a company’s fundamentals because that will likely dictate where the stock will go over time.
The “DRIP” is the secret weapon of a dividend investor
Dividend investors should especially get excited during bear markets. Generating income from your shares is the whole point of a dividend stock strategy. Think of dividend stocks as little money trees. Each share is a tree that gives you fruits (dividends), but selling the shares is like cutting down that tree: it no longer gives you anything once it is sold.
So of course you should be happy if prices go down because you weren’t likely to sell anyway! Lower prices allow you to buy more shares for your money, giving you more dividends.
You can use Dividend Reinvestment (DRIP) to add even more capitalization to your portfolio. Reinvesting dividends means that instead of pocketing the cash from dividend payments, they are automatically reinvested in stock to buy more shares. These stocks pay dividends, which begin to grow with your initial investment.
Simply own tobacco company stock. Altria Group from 1995 to now it would have generated an average annual return on investment of 8% per year. If you reinvested the company’s dividends instead of pocketing them, your annual returns would have almost doubled to almost 15%. Reinvesting dividends can be like pouring gasoline on a fire.
Look for Dividend Stocks
Dividend stocks aren’t just for retirees; they can be part of a lucrative investment strategy if you take advantage of it. Reinvest those dividends to boost your compounding, take a long-term view of your investments, and learn to see bear markets for the fire sells they are.
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Justin Pope has no role in any of the aforementioned actions. The Motley Fool holds positions and recommends S&P Global. The Motley Fool has a disclosure policy.