June 1, 2022
When people talk about making money in stocks, they are usually referring to capital appreciation. After all, when we hear that the Dow Jones Industrial Average or the S&P 500-stock index has set a new record, it is the prices of the shares that is being referred to. But over the years, dividends have contributed importantly to the total return of stocks. A study by Standard & Poor’s reported that since 1926, some 34% of the total return of the S&P 500 has come from dividends. In the 1940s and again in the 1970s, dividends were responsible for 50% or more of the total return!
Here’s another way to look at that phenomenon. If you had invested $1,000 in the S&P 500 as 1926 began and held it for the next 95 years, your investment would have grown to $373,518. That assumes you spent your dividends as you received them. If instead you had reinvested those same dividends in the S&P 500, you would have accumulated $14,086,369! That shows the compounding power of reinvesting dividends. (Data from Kroll 2022 SBBI® Yearbook. Example for illustrative purposes only; you cannot invest in an index.)
That importance of dividends in the total return of large company stocks fell to 14% in the 1990s, when investors were hunting for lightly taxed capital gains instead of dividends. The trend began to reverse when qualified dividends were given the same favorable tax treatment as long-term capital gains. The graph below shows the recent history of stock returns, with and without dividend reinvestment.
However, the stock market as a whole is off to its worst start in more than half a century this year, losing some 16% in the first four months. Even so, stocks remain more expensive than normal. The average price-to-earnings ratio of the S&P 500 over the last 20 years has been 15.7, according to The Wall Street Journal. The multiple reached a high of 24.1 in September 2020. Now it is back down to 16.8.
The volatility in stock prices comes from the sharpest bounce of inflation in more than a generation, and uncertainty about how the Federal Reserve Board will respond to it. The cost of addressing the severe inflation of the 1970s was a sharp recession, which the Fed will be trying to avoid. The war in Ukraine adds still more uncertainty, with the prospect of severe disruptions in international trade. Rising interest rates will depress the value of existing bonds, which suggests that investors will have trouble finding a safe haven for their assets.
As a general rule, equity investments have been able to keep up with inflation, and bond portfolios have not, but the added return comes with added risks.
Are you confident with the role that dividends are playing in your portfolio planning? Would you benefit from getting a second opinion about your investment strategies? Please give us a call; we will be pleased to be of service in this regard.
Over the past ten years, stock prices have trended upward, as shown by the red line in the graph below. The data is for large company stocks, and comes from the Kroll 2022 SBBI® Yearbook. The total return from stocks includes dividends as well, and those dividends are reinvested in stocks for compounding growth. The blue line shows the total return of large company stocks since 2011.
Source: Kroll 2022 SBBI® Yearbook