Dividends Reward Discipline
Dividends can be a surprisingly controversial topic, but they are an important aspect of total return and can help grow your portfolio through reinvestment. Tuesday, 28 February 2023
The traditional approach to dividends is that they are an important supplement to generating income and can be used to support a steady withdrawal rate in retirement. An updated approach is that dividends are an important aspect of total return and help grow a portfolio through reinvestment. We’re exploring this topic today, using historical data from the S&P 500 to illustrate important points for investors.
Hi everyone, Jay Pluimer here with Flourish Insights. As the director of investments at Flourish Wealth Management, I take pride in providing our clients, colleagues, and friends with resources and information that can help them make strategic and effective choices regarding their investments. Did you know we have an Alexa Skill? To listen on your Alexa device, just say, “Alexa, play Flourish Insights.”
Today, we are reviewing the impact dividend income has on long-term performance by stating that Dividends Reward Discipline.
Dividends can be a surprisingly controversial discussion topic for investors and investment professionals. The traditional approach to dividends is that they are an important supplement to generating income and can be used to support a steady withdrawal rate in retirement. An updated approach is that dividends are an important aspect of total return and help grow a portfolio through reinvestment. Basically, dividends can be used to support distributions or be reinvested for long-term growth. In this episode, we will focus on the benefits of reinvesting dividends as part of a disciplined approach for long-term investors.
I will be referencing information and statistics for the S&P 500 Index throughout this episode, so this is a quick reminder that the S&P 500 measures performance for the largest 500 companies on the US Stock Market. The companies in the S&P 500 change over time, based on market movements, and can be significantly different over time. This Index has the most reliable historical data and is a good reflection of US Large Cap stocks at any point in time. Although there are other good indexes to capture historical performance for this part of the market, the data I will reference over the next few minutes is all for the S&P 500.
From 1928 to the end of 2022 the stock market increased by 21,500%, which leads to an annualized return of 5.8%. That is the return for the price of the Index and doesn’t include reinvested dividends. Although 5.8% is a solid return, the S&P 500 Index returned 9.9% annually when dividends are reinvested and included in the total return calculation. In other words, reinvesting dividends resulted in a return that was almost 70% higher over a 95-year time period.
My initial reaction to these numbers was surprise because I did not think dividend payments of a few percentage points a year would add up to such a big difference in returns. The gap is huge when comparing the growth of $1 from 1928 with price increases alone growing to $216 compared to $7,500 with dividend reinvestments. This is where the word discipline comes in because a significant part of the performance difference is due to compounding.
Frequently referenced as the 8th Wonder of the World, a quote that is most often attributed to Albert Einstein, compounding reflects the impact of dividend payments from 80 or 90 years ago that are allowed to grow over time. The disciplined part is to let the dividends continue to grow instead of cashing them out to cover short-term spending needs. The longer the time period an investor has, the more compounding will work in their favor. In fact, once the historical performance data is broken down into components it becomes clear that dividends are not a magical source of investment returns; instead, the point is that leaving money in the market for multiple decades will increase the opportunity to maximize long-term gains.
Reinvesting dividends to support higher long-term performance is an important aspect of being a disciplined investor. In addition, minimizing fees and taxes will result in better long-term returns, as will continuing to add money to your portfolio regardless of the market environment. Our goal at Flourish is to help clients follow a disciplined investment approach to capitalize on opportunities that reward long-term investors, while encouraging all investors to embrace these evidence-based concepts.
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