How Important Are Dividends?

23/05/2014

An investor in equities benefits from potential capital growth and income in the form of dividends. The stock market indexes quoted on the news do not account for dividends generated by the underlying shares, so are they unimportant?

In recent years shares that provide a high dividend income relative to their price have been highly sought after by investors. This is partly due to the fact that many investors want income and the interest rates on bank accounts have been very low.

linechart(1)The above chart shows three returns on the S&P 500 over the last 20 years.

In 1994 the S&P was at 443 and in the next 20 years the value of the index grew to 1878. The blue line is the growth in the index, a return of 323% over the the last 20 years. That’s a compound growth rate of 7.5% per annum.

The red line is the growth in the index with dividends reinvested after deduction of tax. This shows a return of 470% or a compound annual rate of return of just over 9%. This means that over the last 20 years dividends on the S&P 500 have been worth an extra 1.5% per annum to investors after deduction of tax.

The green line is the gross total return which is the capital return plus dividend reinvested without deduction of tax. The total return here was 521.61%, an annual compound rate of 9.5%.

So dividends have been worth an extra 2% per annum to investors in the S&P 500 over the last 20 years. Whilst this may appear a small difference on an annual basis, through the magic of compounding it has generated an additional 200% growth in value of the portfolio. A significant benefit if the dividends were reinvested back into the index.

I hope the above is useful. Please let me know if you have any questions or comments.