Capital gains tend to be the most exciting portion of stock returns since stock prices fluctuate daily, but dividends have the potential to make a huge difference in your total return over time.
Price Return vs. Total Return
Return figures of indexes like the S&P 500 are often based on the "price return" that only includes price changes of the index (i.e. capital gains or losses). The "total return" figure also includes the dividends that were been paid out by the companies in the index.
The S&P 500 averaged a total return of 9.7% per year over the past 40 years. With dividends removed the return falls to 6.4% per year. So over the past 40 years dividends made up around 1/3 of the total return of large US stocks.
S&P 500 Returns (12/31/1972 – 12/31/2012)
With Dividends
|
9.7% Per Year
|
Without Dividends
|
6.4% Per Year
|
To put this into perspective, a $10,000 investment would grow to over $400,000 if it compounded at 9.7% per year over 40 years. That same investment would only be worth around $120,000 if it grew at 6.4% per year. That’s a huge difference and illustrates the impact of letting stock dividends compound over time.
Initial Investment Of $10,000 Over 40 Years
@ 9.7% Per Year
|
$405,756
|
@ 6.4% Per Year
|
$119,582
|
*For
educational purposes only and does not take into account taxes, investment costs, and other fees.
How To Profit From Dividends
Hold Value Investments – Adding “value” investments to your portfolio can increase your dividend income since they tend to pay more dividends than “growth” investments. Keep in mind that growth and value tend to fall in and out of favor over time, so you might want to have a mix of both in your portfolio.
Don’t React to Market Swings – Instead of panicking out of stocks during downturns, focus on the fact that you’re able to buy shares at a discount with your dividend income. And remember that you won't receive the dividends if you sell your stocks during the downturn.
Be Careful Of Equity-Indexed Products – Some advisors sell annuities and insurance that promise “equity returns” without losses. Unfortunately most of these products use the “price index” that leaves out dividends, so your long-term expected return will be much lower than you might think.
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