reinvesting is a time-honored method of building wealth. Even when market
gains slow down, dividends offer
regular and dependable income that, when reinvested, quickly ramp up the value of your portfolio.
Dividend reinvestment even makes sense in a falling market. There is an inverse relationship between dividend yields and stock prices. This means when stock prices decrease, dividend yields increase. Reinvesting the increased yield back into lower-priced stocks creates an automatic compounding effect that can dramatically increase your bottom line over time.
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Believe it or not, since 1920, dividends have accounted for 40% of the gains booked in the S&P 500. Investors who don't participate in dividend reinvestment miss out on a huge part of the stock market's gains over time.
When it comes to a successful dividend reinvestment strategy, there are three key aspects you should consider.
1. Don't touch your principle
Your principle or nest egg is the must-have tool to earn dividend income for reinvestment. Decreasing your principle by selling shareswill noticeably increase the time needed to reach your financial goals. Even during times of dropping stock prices, when it will be tempting to get rid of a stock, time has proven this isn't a wise move.
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2. Keep your costs low
The lower your investing costs, the higher your potential profits. In the volatile world of stock investing, costs are the one thing completely under your control. Think of dividend reinvesting as a business, so try to keep your business costs low. Find out what your broker charges and shop around for the best price.
3. Only invest in companies that historically increase dividends
This is perhaps the most important aspect in successful dividend investing. Not only are companies that regularly increase dividends generally more stable, but increasing dividends is the assurance that your dividend income retains its purchasing power over time.
My colleague Carla Pasternak, the face behind High-Yield Investing, teaches these same concepts. Carla likes to find reliable stocks that regularly increase dividends. She calls these "Retirement Savings Stocks." Whether you are currently retired, about to retire or just starting to build a nest egg, I think the best time to buy Retirement Savings Stocks is now.
Many investors are concerned about the potential dividend tax increase slated to take place on Jan. 1, 2013. It's still uncertain whether a solution to the country's fiscal problems will be reached by the end of the year, when the automatic tax increases will be enacted. But investors should keep in mind that history has shown that previous changes to the dividend tax rate only have a short-term effect on dividend stocks. Generally, within six months of the tax change, dividend stocks return to their normal valuations. If the worst-case scenario happens and dividend taxes increase, then dividend-paying stocks will likely still offer superior returns and provide those who live off their investment income with a wiser choice than selling shares and being hit with capital-gain taxes.
And there are many great Retirement Savings Stocks that regularly increase dividends. Here are three of my favorite stocks right now...
1. Aflac Inc. (NYSE: AFL)
Well known for its TV commercials featuring a duck, Aflac is a supplemental insurance company that pays a dividend yield of 3%. It has increased its dividends consistently during the past 30 years. Although the dividend has risen by only about 6% in 2012, it has increased by an average of 11% during the past five years. The company's earnings-per-share (EPS) is forecast to improve 11% each of the next five years. Based on these metrics, it's extremely likely Aflac's history of dividend increases will continue.
2. Abbott Laboratories (NYSE: ABT)
Boasting a market capitalization of nearly $100 billion, this pharmaceutical kingpin is a leader in its field. During the past five years, the company has increased dividends at an average annual rate of roughly 9.5%. EPS is forecast to grow about 8.5% per year and will likely allow the dividend increases to continue. It currently pays a dividend yield of 3% on a payout ratio of 50%.
As a point of interest, the company is about to split into a medical products business named AbbVie, while Abbott will continue to focus on medical devices, nutritional products and diagnostics. This split will likely be very positive for the stock price. I focused on the benefits of these types of corporate actions in this article.
3. Eaton Corp. (NYSE: ETN)
This aerospace, power management and hydraulic components maker grew its EPS by an average of 6% per year during the past five years. The growth is projected to continue at a 9% rate for the next five years. Dividends increased at an average rate of 12% during this same time frame. Currently, its dividend yields roughly 3%. The historic and projected EPS growth paints a powerful case for continued dividend increases.
Risks to Consider: It's important to remember that nothing is ever for certain in the stock market. Long-time dividend-yielding stocks that appear solid can suddenly stop paying or even suffer steep declines. Always use stops and be sure to position size properly when investing.
Action to Take --> The three stocks listed above are strong contenders for everyone's dividend reinvestment portfolio. And while I won't presume to speak for Carla, I think they fit the bill for Retirement Savings Stocks pretty well. Their proven record of dividend increases and unyielding performance metrics creates a compelling case for each of the companies.
-- Dave Goodboy
Dave Goodboy does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.