I’m trying to understand the benefits of dividend stocks. I usually hear they generate “passive income” but from what I can tell, the dividend you receive is a tiny fraction of what you paid for the stock itself, and would take decades to recoup what you paid for the stock. Setting aside the possibility of stock price appreciation, how is receiving a small dividend better than keeping the lump sum you would have paid for the stock to begin with. What am I missing?
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“How is receiving a small dividend better than keeping the lump sum you would have paid for the stock to begin with. What am I missing?”
A key concept in economics is opportunity cost, meaning the profits/benefits/decisions one had to forgo in order to make a certain economic choice like spending. Using the example of a $10 stock with a 1% dividend, if you had a different way to spend the $10 that would provide you with greater than a $0.10 return by the end of that year (e.g., lend a friend the $10 and get paid back $12 by year-end), then you’d be right that the small dividend was not worth spending that $10 on the stock purchase. In the example above, we’d say that the opportunity cost of buying the stock was $2-$0.10 = $1.90.
If however, your only alternative to buying the $10 stock was to ‘keep a lump sum’ and do nothing with it, in which case you’d be generating a $0 return on the $10 instead of the $0.10, then you’re still better off buying the stock.
In reality, these decisions also need to factor in risk (e.g., high probability of making 10% on a dividend stock vs. low probability of making 50% on a value stock), inflation (e.g., that tiny 10% return can still negate inflation that would otherwise cause your $10 to be worth less after a year if you just held onto it).
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