5 Reasons That Dividends Matter

They're a big chunk of your profits

Although Standard & Poor's 500-stock index currently yields just 1.9%, dividends have historically accounted for 43% of the U.S. stock market's long-term return of nearly 10% annualized. And dividends tend to be more predictable than stock prices. P&G's current yield is 2.8%.

They can grow

With the overwhelming majority of bonds, the interest rate you see is the interest rate you'll get until the bond matures. By contrast, companies can boost their dividends. Over the past 25 years, the dividends paid out by companies in the S&P 500 have grown at a compounded rate of 3.2% per year. P&G, which has raised its payout 53 years in a row, is one of 43 so-called dividend aristocrats that have lifted their dividends for at least the past 25 consecutive years. Over that period, P&G's dividend has climbed an average of 10% a year.

They help protect earnings from the IRS

The current top federal tax rate on qualified dividends is 15% (if you're in the 10% and 15% brackets, you pay no tax on qualified dividends). However, unless Congress extends the Bush tax cuts that are due to expire this year, dividends could be taxed at the same rate as ordinary incomeÑas high as 39.6% -- starting in 2011.

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Dividend-paying stocks shimmy less

Dividend-paying stocks are usually less volatile than nonpayers. One way of measuring volatility is beta, which indicates how closely a stock tracks a particular index. A stock with a beta of 1 tends to follow the S&P 500 index closely. One with a beta of, say, 1.3 tends to jump up or down 30% more than the index; one with a beta of 0.9 tends to jump 10% less. Over the past five years, the average beta of dividend-paying U.S. stocks has been 0.98, while that of nonpayers has been 1.50. P&G's beta is 0.55.

The stocks stay afloat in rough markets

Dividend payers usually do better than nonpayers when the stock market tanks. In the catastrophic year of 2008, for instance, stocks that paid dividends lost an average of 39% on a total-return basis, while those of nonpayers tumbled 45.4%. The contrast was even starker in 2002, the stock market's second-worst year of the decade. That year, nonpayers plunged 30.3%, while dividend stocks surrendered only 10.9%. Including dividends, P&G shares lost a modest 15.8% in 2008 and actually earned 9.4% in 2002.