Understanding Dividends as the Federal Reserve Lowers Interest Rates

Jack Bogle, a respected investor, once said that "successful investing is about owning businesses and reaping the huge rewards provided by the dividends and earnings growth of our nation's—and, for that matter, the world's—corporations." This idea matters today because investing in stocks isn't just about watching their prices go up. It's also about the dividend payments that companies give to shareholders as they make more money.

Right now, stock prices are very high while dividend yields (the percentage of a company's stock price paid out as dividends) are very low. The S&P 500 is expected to pay about 1.3% in dividends over the next year. The last time dividends were this low was in 2000 during the dot-com bubble. The Federal Reserve's recent interest rate cuts also affect how investors can earn income from their investments.

Many people think dividends are boring compared to exciting tech stocks. But dividends shouldn't be ignored. They add up over time and provide steady income, especially when stock prices jump around. Companies that both pay dividends and see their stock prices rise can give investors regular cash plus long-term growth.

Dividend yields vary widely across market sectors

How investors view dividends has changed a lot over the past 100 years. For most of the 1900s, dividends were a main reason people bought stocks, often paying 5% to 7% per year. People bought stocks mainly for the income, similar to how people buy bonds today. Stock price increases were less important than dividend payments.

This started changing as investors became more interested in growth and technology companies. During the 1990s dot-com boom, dividends became even less important. High-growth tech companies preferred to reinvest their money rather than pay dividends. Companies also started buying back their own stock instead of paying dividends because it was more tax-efficient.

As the chart shows, technology sectors like Information Technology and Communication Services pay the lowest dividends today—between 0.6% and 0.8%. These include the Magnificent 7 stocks, which generally pay low or no dividends. Meanwhile, sectors like Real Estate, Energy, and Utilities pay over 3% in dividends. This shows that higher dividend payments are available in certain parts of the market.

Company decisions and interest rates impact dividend attractiveness

Companies can use their profits in two ways: reinvest in their business or pay dividends to shareholders. Companies typically pay dividends when they don't need all their cash for growth opportunities, or when their business is designed to generate income for shareholders, like real estate investment trusts (REITs).

But dividends do more than just return extra cash. Many companies pay steady dividends to attract investors and show they're financially stable. Growing dividend payments signals that management is confident about future earnings.

Interest rates also matter. When Treasury bond yields are higher than dividend yields, bonds look more attractive. Right now, 10-year Treasury bonds pay about 4.1%, which is much higher than the overall stock market's dividend yield. As the Fed continues lowering rates, this comparison could change, making dividend stocks more appealing.

Dividends contribute significantly to long-term returns

For investors, dividends are an important part of total returns. According to Standard and Poor's, dividends made up 31% of the S&P 500's total return since 1926, while stock price increases made up 69%.1

The chart shows that $1 invested in stocks in 1926 grew to about $18,000 by 2025. This growth came from both dividends and price increases, though the mix varied over different time periods. The key was staying invested through different market cycles.

For people nearing retirement, generating income becomes more important. However, focusing only on the highest-yielding investments can be risky. "Yield chasing" can lead to poor diversification and investments in companies that can't sustain their dividends. Instead, investors should balance dividends and growth based on their financial goals. This "total return" approach helps portfolios perform well in different market conditions.

The bottom line? Even though dividend yields are near historic lows, dividends remain important for investors. A balanced approach that considers both stock price growth and dividend income can help you reach your financial goals.

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1. https://www.spglobal.com/spdji/en/documents/research/research-sp500-dividend-aristocrats.pdf