The Quiet Power of Dividends

Like Rodney Dangerfield, dividends don’t get any respect.

They aren’t flashy. They don’t dominate headlines. They rarely fuel cocktail-party conversations or social-media bravado. In a market obsessed with price momentum, dividends can feel like the broccoli of investing — nutritious, dependable and routinely ignored in favor of something more exciting.

That lack of attention is understandable, at least on the surface. With the Dow near record highs and the S&P 500 yielding barely north of 1 percent, dividends can seem irrelevant. Why focus on income when prices are soaring?

But markets have a way of humbling those with short memories. When you step back and study history, dividends quietly reveal themselves as underappreciated stabilizers of investor behavior — and one of the most important drivers of long-term wealth.

Over the past century, roughly one-third of the S&P 500’s total return has come not from rising prices, but from dividends and their reinvestment according to Harford Funds. In other words, 33% of the overall growth of the market can be attributed to dividends. Remove them from the equation, and long-term results look dramatically different.

Charlie Munger spent a lifetime warning investors about the danger of focusing on what’s easy to see instead of what truly matters. “The big money is not in the buying or the selling,” he said, “but in the waiting.” Dividends reward waiting. They compensate patience, discipline and emotional restraint — qualities that are the hallmarks of good investor behavior.

Dividends also address one of the most serious threats to long-term financial security: inflation.

Inflation isn’t dramatic in the short run, but over decades, it is relentless. Warren Buffett once described inflation as a “tapeworm” slowly eating away at purchasing power. The only reliable antidote is owning assets with a growing cash flow that outpaces cost-of-living increases.

Here’s the overlooked fact: Since at least 1960, dividends paid by U.S. companies have grown at roughly 1.5 times the rate of inflation according to data from the Federal Reserve. For retirees and near-retirees, this growth is essential. If income doesn’t expand, lifestyle shrinks.

This is why Buffett has always emphasized owning businesses with pricing power — companies that can raise prices without losing customers. Those same companies tend to maintain and grow dividends through good times and bad.

When bad times arrive (which they always will), market volatility can often lead to bad investor behavior. Prices move far more violently than business fundamentals, and that disconnect fuels panic.

During the major market declines of the last fifty years, prices routinely collapsed far more than earnings, and earnings declined far more than dividends according to data from Yardeni Research. In the 1973–1974 bear market, stock prices fell nearly 50%, yet dividends held steady. During the dot-com bust, prices fell again by nearly half, while dividends barely budged. Even in the global financial crisis — when prices fell 57% and earnings dropped sharply — dividends declined only briefly before resuming their growth almost immediately afterward.

When prices are falling but income continues to arrive, investors are far less likely to abandon sound strategies at precisely the wrong times. Munger often reminded us that volatility is not risk; permanent loss is. Dividends help investors tell the difference.

Here’s a simple behavioral insight that matters more than most charts: If investors checked their dividend income every 90 days instead of their account balances every 90 minutes, I believe they would make far fewer catastrophic mistakes.

Dividends also become even more powerful when paired with tax-advantaged accounts. Buffett has often pointed out how the tax code can be an enormous factor in long-term outcomes, yet most investors fail to fully appreciate its impact. It can allow you to hold the same stocks in the same market while getting an entirely different result.

In a 401(k) or traditional IRA, contributions go in pre-tax. Dividends are credited pre-tax. And reinvested dividends compound pre-tax. That’s three layers of advantage working simultaneously. Effectively, this gives you an interest-free government loan on money you’d otherwise pay in taxes; you repay only after the compounding has done its work.

Dividend reinvestment also enforces a discipline Munger deeply admired: systematic behavior. Reinvested dividends automatically buy more shares when prices are low and fewer when prices are high — without reacting to emotion, forecasts or headlines. Over time, those additional shares, purchased because of systematized discipline, compound.

Research consistently confirms this logic. My experience leads me to believe stocks with moderate, sustainable dividend yields have produced the best risk-adjusted returns over long periods. On the contrary, extremely high yields often signal distress and are typically a reason to avoid a potential investment.

Slow-growing dividends often signal durable businesses. Think of companies that sell essential goods and services, possess pricing power, and steadily raise payouts. They may not tell exciting stories, but they are often compounding machines.

With even modest inflation, a flat income is cut in half over the length of a typical retirement. That’s a difficult hurdle to overcome in even the most robust “buy low, sell high” strategy.

Growing income is mandatory for those who want to preserve their standard of living. Dividends can provide that growth. Reinvestment can accelerate it, and tax deferral strategies can amplify it. When this is done over long periods, something remarkable happens: Patience turns into purchasing power.