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Bill Freehling is a business writer for The Free Lance-Star and Fredericksburg.com. This blog is on Fredericksburg-area business. Send an e-mail to Bill Freehling.
It’s a good time to reinvest
It’s hard to find a ray of hope in the current economic and investment climate, but I’ll try anyway.
Every day, it seems, the headlines get worse. Housing prices and construction dropping. Banks writing off billions of dollars worth of bad loans. Unemployment and foreclosures rising.
The stock market has reacted in predictable fashion, with the Dow Jones Industrial Average shedding triple digits on a seemingly daily basis.
Now the silver lining.
Bear markets can be good for long-term returns if investors have the courage and conviction to buy shares of solid companies through the declines. Two of the most disciplined ways to do this are reinvesting dividends and dollar-cost averaging.
Renowned financial author Jeremy Siegel wrote about this strategy in his excellent 2005 book, "The Future for Investors."
Siegel’s primary thesis is that "tried and true" companies with long histories of rising dividend payouts ultimately yield better returns than "the bold and the new." Everyone would love to invest early in the next Google, Apple or Microsoft, but good luck identifying that company ahead of time.
Siegel shows ample data to illustrate that dividend-paying stocks are the safest and best bet for most investors, especially during brutal market stretches such as the one we’re in now.
Chapter 10 of his book is titled "Reinvested Dividends: The Bear Market Protector and Return Accelerator."
Investors who bought the Dow Jones Industrial Average stocks in September 1929, the height of the Roaring ’20s bull market, wouldn’t have seen prices rise until November 1954. That 25-year stretch was the worst in the Dow’s history.
But stockholders who reinvested their dividends during that stretch realized an annual return of more than 6 percent. A person who invested $1,000 in the Dow stocks in 1929 and plowed the dividends back into more shares would have had $4,400 by 1954.
In fact, Siegel shows, long-term results would have been far worse if prices had never dropped. The steep declines allowed resolute people to buy more shares of quality companies with their reinvested dividends.
"The extra shares purchased during the bear market caused their returns to rocket ahead when stock prices finally recovered," Siegel writes.
Many companies have dividend reinvestment plans (DRIPs) that allow stockholders to automatically purchase additional shares with payouts. There are also a number of exchange-traded funds that focus on stocks with a history of rising dividends.
A lot of companies of late have chosen to use excess cash to repurchase their shares on the open market rather than pay it out to shareholders. For a list of companies with a long history of increasing dividends, check Dividendachievers .com. Most financial Web sites have lists of high-yielding stocks.
Tread carefully, however. A lot of the dividend achievers are financial stocks, some of which, including Citigroup, have recently announced dividend cuts.
A strategy that’s similar to reinvesting dividends is dollar-cost averaging. That’s when you put a set amount of money into a mutual or index fund every month. You get more shares during market slumps, fewer when times are good.
It’s a good way to stay disciplined and take the emotion out of investing. Anyone who has a 401(k)-type plan at work already does this.
It’s certainly painful to keep buying stocks when they’re dropping like rocks. But historically it’s been a good way to make your money grow in the long-term.
That’s a potential silver lining in these tough times.