Growth stocks have led the pack in recent years—even accounting for the rough 2022 where they underperformed. Market darlings like Nvidia (NSDQ: NVDA) and Tesla (NSDQ: TSLA) have made tremendous gains. NVDA is up sevenfold over the last five years, while TSLA is up by more than 12 times.

The returns of these stocks have come strictly from price appreciation. Companies in pursuit of high growth typically reinvest most, or all, of their free cash back into operations, thus not paying their shareholders a dividend. TSLA does not pay a dividend, while NVDA pays a negligible one.

Dividends Account for Big Chunk of Return

However, if we take a step back, for the broader market it is clear that dividend is a big part of one’s stock investment return. In fact, between 1960 and 2022, about 70% of the S&P 500’s total return can be attributed to reinvesting the dividends received. Thus, the importance of dividend shouldn’t be ignored.

When a company pays a dividend—better yet, a growing dividend—it is a sign of good financial health. It’s typically a reflection of growing sales, profits, and cash flow. To be clear, investors should still examine a company’s public filings and not assume that a company’s finances are in good shape solely because it pays a dividend.

Because of the stigma of cutting dividend, a company will usually try to avoid taking that step for as long as they can, sometimes to the detriment of its wellbeing. In other words, to keep paying out a dividend, a struggling company may even take on debt or use cash that would be better used for other purposes. This is why it’s helpful to study a company’s sales trends and cash flow to see if the dividend is sustainable.

However, the rule of thumb is that if a company is consistently increasing its dividend at a constant or even accelerating rate, it’s generally a good sign for shareholders. Thus, even ignoring the income for a moment, the fact that a company pays a dependable and growing dividend is an attractive quality.

Reinvest or Invest in Something New

Cash dividends received can be reinvested into the same stock, so you end up with a growing number of shares over time. Many companies offer DRIP (dividend reinvestment program), where instead of paying you a dividend, that cash is automatically used to buy more shares of the stock, often at a small discount.

Automatic reinvestment is how the S&P 500 Total Return Index treats dividends. Assuming that a stock’s long-term trajectory is up, the dividend reinvested will result in additional return. (A quick side note, even if reinvested automatically, the dividend is still taxable.)

There’s nothing to force you to reinvest the dividend in the same stock. The dividend is yours and you can use it however you want to. You can spend the cash, or you can invest it in something else. If you reinvest wisely, you may even be able to achieve a higher return with the new investment than if you automatically reinvested.

Favorable Tax Treatment and Hedge Against Volatility

Dividends are attractive in another way. Qualified dividends are taxed at no more than 20%. For middle-class Americans, the tax rate is typically 15%. Thus, the dividends provide you with an additional source of income that is taxed at a lower rate than normal wages or salary while you still hold the stock.

During rough times for the market, when investor risk aversion rises, dividend-paying stocks can serve as a haven for those seeking to reduce risk. As a result, dividend payers tend to outperform the more exciting high-growth stocks during volatile markets.

Of course, as useful as dividends are, in investing there’s no such thing as one size fits all. What strategy fits you the best depends on your own investment goals and personal situation. Whether you love high-flying growth stocks or you prefer more conservative dividend-paying stocks, however, you need to do your due diligence and know what you are investing your hard-earned money in.

Editor’s Note: Scott Chan just explained important investing principles that can help you make money. But does uncertainty in the financial markets have you on edge? The key to mastering risk resides in what our colleague Jim Pearce calls “Mayhem Trades.”

Jim Pearce is chief investment strategist of our premium trading service, Mayhem Trader. Jim has developed an under-the-radar strategy to flip market mayhem into fast payouts. Want to learn more? Click here now.

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