Why dividend stocks are ‘magic’ for younger investors

Dividend-paying stocks are popular among retirees, and for good reason: The cash that companies distribute to their stockholders is a form of truly passive income.

A retiree with a $1 million stock portfolio paying a 3% average dividend yield can expect $30,000 a year just for holding the stock. But dividend-paying stocks have plenty to offer younger investors, too, says Jim Cramer, host of CNBC’s “Mad Money” and author of “How to Make Money in Any Market.”

“I love dividends,” Cramer tells CNBC Make It. “And the reason why I love dividends is: If you keep them in your fund by reinvesting them, you end up with just a huge amount of stock that you never thought [you’d have].”

In other words, if you take your cash distributions and use them to buy more stock, you can build wealth that much faster.

A quick reminder of how dividends work: Profitable companies have a choice of what to do with their excess cash, and many financially mature firms issue cash distributions to shareholders as a sort of “thank you” for their loyalty.

You can calculate a company’s dividend yield — which reflects the generosity of a firm’s payout — by dividing the amount of cash you receive per year, typically divvied up in quarterly payments, by the stock’s share price. A stock worth $100 per share that pays a $1 annual dividend yields 1%.

The S&P 500 currently yields 1.17%, which may seem like small potatoes compared with the index’s prodigious returns in recent years. “Most of the time people don’t even consider dividends as too important,” Cramer writes in his book. “They seem small, a couple of percentage points at best.”

But over long periods, reinvested dividends can have an outsize impact on investment returns, due to compound interest, says Cramer.

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“The great part of investing is how much more you make if you compound,” he says. “Do you know, about half of the [return of the] S&P since the time I’ve been in the business is from the [dividends] compounding?”

Say you buy $100 worth of stocks, and after a year, they’re worth $110. Based on the movement in the value of your shares, you’ve earned a 10% “price” return. What if the stock had a 2% dividend yield, too? If you use that dividend to buy more shares, now you have $112 worth of stock for a 12% “total” return.

Do that year after year over a career as long as Cramer’s — he writes that he started “investing seriously” in 1982 — and it’s easy to see how things add up.

The further you go back, the bigger a dividend’s impact. From the start of 1960 through 2024, a $10,000 investment in the S&P 500 would have earned you roughly $982,000 based solely on price appreciation, according to mutual fund and ETF provider Hartford Funds. Over the same period, that investment with reinvested dividends would have grown to $6.42 million, with the dividends accounting for 85% of the index’s total return.

It’s no wonder, then, that Cramer describes dividends as “magic” – as long as younger investors consistently use them to bolster their investments.

“You cannot take your dividends out,” he says. “If you’re doing my program [and] you take the dividends out, I can’t help you.”

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