With interest rates set to stay low over the coming years, dividends are likely to remain of huge importance to a significant proportion of investors. Certainly, interest rates may not remain at the historic low of 0.5% over the medium term. But with inflation being near-zero and showing little sign of rising despite a loose monetary policy having been adopted, the Bank of England seems to have limited scope to raise interest rates in the coming months.
In addition, policymakers are likely to be rather nervous about raising rates. After all, the US Federal Reserve increased interest rates by 0.25% in December and have been at pains to point out that rises are likely to be slow, rather than fast. However, investors have become increasingly fearful of the potential impact of a rising interest rate in recent weeks and this response may signal to the Bank of England that the market isn’t yet ready for interest rates to head northwards.
This potential lack of monetary policy tightening means that cash balances are likely to disappoint when it comes to interest payments. As such, income in the form of dividends is likely to become relatively more important in the coming years.
High returns
Dividends are also a Fool’s best friend because history has shown that they account for the majority of total investment returns. Certainly, all investors love to unearth a stock that goes on to double or even treble. But the reality is that most stocks don’t offer such a high level of performance, and that the more modest share price performance of other stocks reduces the overall capital gain for a portfolio.
On the other hand, dividends and their reinvestment offer stable, resilient and consistent growth over a long period. That’s why buying stocks that offer a high yield and the prospect of upbeat dividend growth could be the best way to achieve financial goals in the long run.
Defensive attributes
Dividends indicate that a company is financially sound. With the market outlook being highly uncertain at the present time, this could lead to increased investor demand for high-yielding shares. That’s not to say that companies with low yields should be avoided. But a company’s attitude towards the proportion of dividends paid out and to the growth in shareholder payouts may help to improve investor sentiment towards it during troubled economic times.
This defensive appeal may help to lessen volatility, but also allow an investor to take advantage of lower share prices in the wider market via the investment of dividends received. In other words, dividends provide much-needed cash flow during periods of depressed asset prices and this income, when reinvested, can go on to not only provide more dividends, but also offer high capital returns too.
Looking ahead
So, while investing for dividends may not be as exciting as investing for capital growth, dividends remain a Foolish investor’s best friend. That’s due to their indication of defensive characteristics, their relative appeal while interest rates are low and also because they’ve accounted for the majority of total investment returns in the past.
