NEW YORK (MainStreet)—Younger investors often gravitate towards "next big thing" stocks and disregard the slower growing, dividend paying stalwarts. But buying those dividend payers, and reinvesting the distributions, is a great way to ensure long term success.
Let's take a quick poll: Raise your hand if you bought or wanted to buy into the Facebook IPO last year.
Like I thought: a lot of you did.
Facebook's going public was a big deal, and a lot of investors, both young and old, wanted in on it.
But the road for FB has been rocky. And a lot of those early investors own shares today that are worth less than what they paid for them.
As a matter of fact, some analysts think that FB shares won't get back to the IPO price for a long time.
If you bought shares hoping to get rich, you've been sadly disappointed. Unfortunately, this is not uncommon for "hot" IPO stocks.
You see many IPOs perform the way FB has. They trade up at first and then sell off, trading for less than its IPO price for years sometimes.
But investors still enthusiastically jump in to every IPO hoping to get rich quick.
The truth is more investors have achieved their wealth slowly by investing in good companies with solid businesses than through big-deal IPOs.
And one of the best ways to build wealth is to look for companies that are not only prospering but are also sharing the wealth with its shareholders by paying a regular dividend.
Younger investors often overlook dividend stocks. That's because they are perceived as boring, and exciting companies, like FB, often do not pay dividends.
Of course, when you hear stories of twenty-something CEOs becoming billionaires, it's easy to see why the FBs of the world attract all the attention...
But dividends are crucial to building wealth.
Let's say we own 100 shares each of two companies. Both are valued at $20.00 per share. One pays a quarterly dividend with an annualized yield of 3% while the other pays no dividend.
Using a Dividend Reinvestment Calculator, it is easy to calculate the benefit you'll get from dividends that are reinvested.
If both of our stocks grow at an average annual return of 6% for 30 years, the company without a dividend will be worth $11,486.98 at the end of that period.
That might seem acceptable until you see how much you made in the other company after reinvesting the 3% dividend every year.
The value of the dividend-paying company after 30 years would be $83,353.98.
Huh? How can that be, you ask?
You see, when you reinvest the dividends you buy more shares. So every quarter you are increasing the number of shares you own and also the amount of income you are receiving...
...which means you are buying more and more shares every quarter. This is a vivid demonstration of the benefit of compounding.
In our example, we started with 100 shares of each stock. After 30 years, we still had 100 shares of the stock that doesn't pay a dividend while we ended up with 725 shares of the stock that does pay a dividend.
More shares means more money...
And while the second stock also grew at 6% per year, the reinvested 3% dividend boosted its average rate of return to 13.24% - more than double that of the other company.
This is really important for all investors to understand. But if younger investors get on board early, this can really make a big impact for them down the road.
Just by making sure that the stocks you buy pay dividends and that you have those dividends reinvested in more shares, you can significantly improve you investment performance.
Think about that. In our example, the average rate of return was double – but that doesn't translate into you having twice as much money; it translates into you having a pile of money many times bigger.
This brings me back to Facebook.
Oftentimes IPO stocks are unproven. In Facebook's case, that was certainly so and after going public a company's books essentially become public record – a public company can't hide behind excitement and perception.
But companies that pay dividends are usually well-established companies with track records to consider. They are often reliable businesses that may not grow super-fast but will grow consistently and pay that all-important dividend.
Will Facebook be like Google or Apple in the coming years? Maybe. And I'm not saying it won't.
But I don't know if it will or not.
I can be more certain where other companies may be down the road and confident in estimating what the positive benefit of owning them will be for me and my financial future.
Your portfolio should have stocks in it that have the potential for tremendous growth – like Facebook might.
But don't ignore dividend paying stocks. You just might wake up in 30 years and discover that the best investment you ever made was a bunch of boring dividend paying stocks.
Steven P. Orlowski is a financial services industry veteran who has served in a variety of capacities including financial planner, portfolio manager and trader. He brings a wealth of hands-on experience and industry insider perspective to his analysis and commentary. In addition to being a Certified Financial Planner™ he has held the following licenses: FINRA Series 7, 9, 10, 63, and 65 and various state Life and Health Insurance licenses.
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