You go to the grocery store and see that your favorite potato chips are 50% off. Scooping up two bags for one price is a no-brainer.
Then, you come home and log into your brokerage account and see that your stocks are down 50% over the past year. That’s very scary, so you log off to wait for prices to come back up.
Investors react very differently to these two scenarios, yet they are fundamentally very similar. Investors with money to invest, particularly dividend investors, should be embracing falling stock prices, and I’ll tell you why.
Why buy dividend stocks in the first place?
Sometimes companies have “too much money,” an excellent problem to have. Rather than sit on it, they might give it to shareholders as dividends. Investors love dividends because they are actual cash profits from the companies they own shares in. The share price could 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 nearing their golden years. That’s because dividend stocks seemingly have this reputation of being slow-growing, boring 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 S&P Global. If you’ve ignored dividends, there’s a greater chance that you’ve underperformed the index.
Why “bear markets” are great for investors with cash to invest
During a lecture, famous investor Peter Lynch once quipped, “I love volatility.” There are times when the stock market will go down significantly; it’s happened throughout the history of the markets and will likely occur again in the future. Investors are in the teeth of a market decline right now!
The market is like a tide, and individual stocks are like boats. When the tide is strong, almost every stock goes up in value. But when the tide goes out, all the boats go down. So when your stocks go down with the entire market, it’s usually not a reason for concern. Investors should celebrate that they get to buy their favorite companies at a discount.
As long as a company has strong fundamentals, like:
- Growing revenue.
- Positive earnings.
- A healthy balance sheet.
- Competitive advantage over peers.
The stock is very likely to continue going up over the long term. An investor should worry when the share price keeps falling when the market is thriving. Always check a company’s fundamentals because that will most likely dictate where the stock goes over time.
The “DRIP” is a dividend investor’s secret weapon
Dividend investors should get especially excited during bear markets. Generating income from your stocks is the whole point of a dividend stock strategy. Think of dividend stocks as little money trees. Every share is a tree that gives you fruit (dividends), but selling the stock is like chopping down that tree — it no longer gives you anything once sold.
So, of course, you should be happy if prices go down because you weren’t likely to sell anyway! Lower prices let you buy more shares for your money, which gives you more dividends.
You can use dividend reinvestment (DRIP) to add even more compounding to your portfolio. Reinvesting dividends means that instead of pocketing the cash from dividend payouts, they are automatically reinvested into the stock to buy more shares. These shares pay out dividends, which begin to snowball with your initial investment.
Simply owning shares of tobacco company Altria Group from 1995 to now would have generated an average annual investment return of 8% per year. If you reinvested the company’s dividends instead of pocketing them, your annual returns would have nearly doubled to almost 15%. Reinvesting dividends can be like pouring gas on a fire.
Look to dividend stocks
Dividend stocks aren’t just for retirees; they can be part of a lucrative investing strategy if you play it to your advantage. Reinvest those dividends to supercharge your compounding, take a long-term view on your investments, and learn to look at bear markets as the fire sales that they are.
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends S&P Global. The Motley Fool has a disclosure policy.