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Tuesday, June 8, 2010

5 Advantages of Investing in Dividend paying Stocks

Dividends can provide significant advantages to investors that become even more prominent during bear markets. Here's why:

1. Dividends offer ongoing returns year in and year out.
This is a key advantage over non-dividend-paying stocks. This cash return is received even during down or flat markets. Shareholders can use this cash payment any way they want — reinvest it in additional shares (perhaps the most appealing option considering the potential for significant future returns), apply it toward a different investment, save it or spend it.

2. Dividend yields increase during bear markets.
The recent market pullback has provided dividend yields not seen for several years, which are very attractive compared to current interest rates. The compounding effect of even a couple percentage points will have material impact on total return over the long haul.

3. Dividends can provide a cushion in down markets.
A dependable dividend provides support for a stock because, no matter what is happening in the stock market, investors will eventually jump in to buy if the yield is attractive enough. So in market corrections, demand for consistent dividend payers increases as investors move toward safety, while demand for speculative stocks usually decreases. This price support, coupled with the cash return the dividend provides, can soften the impact of market downturns.

4. Dividend reinvestment while stock prices are depressed can enhance returns during market recoveries.
While it might not seem like it right now, both the market and the economy will eventually recover and grow again. When stock prices are depressed, cash dividends can be reinvested into a greater number of shares, which can create a dollar-cost-averaging effect. This can materially enhance returns during market recoveries.

5. Dividends can grow. Historically, many companies have increased their dividend payments over time.
In fact, several companies have increased dividends to shareholders for 15 or more consecutive years. This is one of the main differences between stocks and fixed-income investments, such as bonds, and a key benefit when economic conditions improve. As a result, stocks are not as impacted by changes in interest rates and can act as a hedge against inflation.

With today's low interest rates on cash investments and reduced returns on other asset classes; it's easy to see why many investors are turning to dividend-paying stocks to provide them with attractive yield and capital gain potential. But it's also important to note that dividend-paying stocks are not the be-all and end-all of any investment strategy — every portfolio needs to include a variety of investment types to help reduce exposure to risk.