Do dividends matter in investing?

Do dividends matter in investing?

Dividend investing, like value investing, is sometimes seen as being old fashioned, compared to growth investing, which focuses on the sexier tech sector and fast growing companies which seldom pay any dividends while furiously re-investing for future growth. So, do dividends matter in investing anymore?

To answer this, we look at the role dividends have played in the total returns in various markets around the world. We look at the 2000 to 2020 period, which starts right after the first tech wave, and which has seen the rise of tech stocks such as Google, Ali Baba and Amazon. We find that even in the recent era of growth investing, dividends accounted for two thirds of total returns on average. Also, and more surprisingly, you do not need to faithfully re-invest your dividends to get most of the benefit from dividend investing.

Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.

John D. Rockefeller


Back in the day, dividends were the main reason for investing, as John D. Rockefeller would put it succinctly. But more recently, investing styles have proliferated – from value investing to growth investing to momentum investing. Every time a disruption happens in the financial markets or in the economy, there is no shortage of “experts” and “gurus” who proclaim “this time is different”, and set us off on yet another path in investing.

However, all throughout these upheavals, there is always a small group of people, many of them retirees, who have stuck with dividend investing, in the belief that dividends, giving them cash in their hands, is the only true metric of investment success. After all, the old adage goes:

Profits are an opinion, cash is a fact.

And there is more than a bit of truth in this. After all, with the complexities of today’s accounting standards, with the way revenues and expenses are recognised, who really knows if the reported and audited income or profits of a company are for real? Even cash on the balance sheet can be subject to manipulation. One only needs to recall companies such as WorldCom, Enron, or closer to home, Noble and more recently, Hin Leong, to know that reported, and even audited financial statements are no substitute for the fact of having cash in hand when dividends are paid out.

The problem with dividend investing, of course, is that it is boring. If this is what investing is about, then truly:

Investing should be more like watching paint dry or watching grass grow.

Paul Samuelson

But the romanticisation of investing, the glamour of the hedge fund superstars, have made growth investing, looking out for multi-bagger stocks, much more alluring to the typical investor. Is this true in practice? That’s what we are here to find out!

What is dividend investing all about?

Investing in dividend stocks can be summarised as: Investing in well-established companies with a track record of distributing earnings back to shareholders. There are a few myths about dividend investing, namely that it is boring, it is safe, and it is all about chasing yield, none of which are true!

But those are well known myths and misconceptions about dividend investing. Here, we want to find out more about 2 further aspects of dividend investing, namely:

  • How important are dividends to overall stock investment returns?
  • Is it necessary for every cent of dividends received to be reinvested in the stock to get the benefit from dividend investing?

To address these questions, we are going to look at investments in broad stock indices rather than individual stocks. This is to avoid the noise which comes from an undiversified portfolio. Also, we are going to look at it from an international perspective. One of the problems with assessing different investment strategies is that we look at the stock market indices like the S&P 500 or the Straits Times Index (STI) by default. But indices are not investible in and of themselves. We also conveniently ignore the dividends which the constituent stocks pay out, since it is too tedious to account for them.

To get around these issues, we shall confine ourselves here to looking at Exchange Traded Funds (ETFs) of major global indices (which also provide a historical record of the dividends paid). Sure, there are costs involved in investing in these ETFs, but they serve to give a more realistic view of what investment returns might look like in real life.

Previously, we have already written quite a bit about the use of dividends in a Yield Shield portfolio in a retirement scenario (here, here, here and here) so let’s see if those advantages of dividends extend to a more general case!

Which stock markets should we look at?

The stock indices we will look at are ones which also have ETFs with at least a 15 year track record, so that we can cover their performance over at least two market cycles. These are:

  • S&P 500 index ETF – SPY (from 2000)
  • Straits Times Index ETF – ES3 (from 2002)
  • S&P Europe 350 index ETF – IEV (from 2000)
  • MSCI Europe, Australiasia and Far East (EAFE) index ETF – EFA (from 2001)
  • MSCI Emerging Markets index ETF – EEM (from 2003)

In the following analysis, we use the following rules for looking at how dividends affect the investment outcomes:

  1. No dividends, only capital gains of holding the ETF over time
  2. Dividends received but either saved, spent or reinvested elsewhere. Even where dividends are spent, we assume that it replaces spending from some other sources, i.e. the other sources of spending is saved instead. Our assumption is that this yields 2% in interest or investment earnings
  3. Dividends are reinvested at the start of every year into the same ETF

Finally, since we are looking only at whether dividends matter in investment, we ignore all exchange rate fluctuations. Note that all the ETFs above, with the exception of ES3, are in USD.

The S&P 500 Index of US stocks

Let’s start by looking at the S&P 500, arguably the most well known stock index. This includes the 500 largest companies by market capitalisation in the USA. In the chart below, we look at how an investment of $1,000,000 in Jan 2000 in the SPY ETF would have fared over the past 20 years:

  • The red line at the bottom depicts the capital gain of the ETF investment only (no dividends)
  • The blue line in the middle shows what would have happened if the dividends were saved, or re-invested elsewhere
  • The orange line at the top shows what would have happened if the dividends were all reinvested in the SPY ETF at the start of the following year
Investing in the SPY ETF with and without reinvestment of dividends 2000-2020
Investing in the SPY ETF with and without reinvestment of dividends 2000-2020

In the first 10 years, the S&P 500 went nowhere basically. However, in the next 10 years, it powered ahead strongly. If the investor had re-invested all the dividends faithfully in the SPY, the end result in 2020 would be an investment worth $3.3 million. Not bad for 20 years’ work!

But what is very interesting is that even if the investor did not re-invest in the SPY, because it was too tedious to do so, and simply saved the dividends, the final value would be $2.8 million. What this means is that capital gains accounted for 56% of the possible gain from investing in the SPY over 20 years, dividends another 21%, and reinvestment of the dividends a final 23%. In short, dividends account for almost half of the total gains from investing in the SPY!

In numbers:

 2000 to 20202000 to 20102010 to 2020
Total Gain233%-8%241%
Annual Return 6.20%-0.83%13.73%
From Capital Gain130%-23%154%
From Dividends50%16%30%
From Reinvestment of Dividends53%-1%24%

The Straits Times Index of Singapore stocks

Now, let’s look at our very own Straits Times Index. This market cap-weighted index of Singapore has undergone several changes over the years, and now covers the 30 largest companies. It was not really investible until 2002, when the first ETF based on it, ES3, was listed. How has an initial $1,000,000 investment in this STI ETF in Apr 2002 fared over the years?

Investing in the ES3 ETF with and without reinvestment of dividends 2002-2020
Investing in the ES3 ETF with and without reinvestment of dividends 2002-2020

While the STI has not risen for the past 10 years, it did quite well in the previous 8 years. As a result, the initial $1,000,000 investment would have grown to $$3.4 million at the start of 2020, with all dividends re-invested in the ES3 ETF.

Looking more closely, out of the maximum possible gains on the initial investment, we see that 36% came from capital gains (a low number, as the STI did not gain much), 47% of it came from dividends, and finally 17% came from re-investment of the dividends. In short, dividends account for almost two-thirds of the returns from investing in the STI!

In numbers:

 2002 to 20202002 to 20102010 to 2020
Total Gain241%117%124%
Annual Return 7.05%10.19%4.60%
From Capital Gain86%62%23%
From Dividends114%41%50%
From Reinvestment of Dividends41%14%51%

The S&P Europe 350 Index of European stocks

Turning now to Europe, we can invest in the S&P Europe 350 index of the 350 largest European listed companies through the IEV ETF, which was first listed in 2000. Again, we use the same colours in the chart below to show how an initial $1,000,000 invested in 2000 would have done over the past 20 years.

Investing in the IEV ETF with and without reinvestment of dividends 2000-2020
Investing in the IEV ETF with and without reinvestment of dividends 2000-2020

European stocks, it appears, had an even wilder ride in the period 2000 to 2010 than the S&P 500. However, some of that incredible volatility could have come from the EUR-USD exchange rate, since the common currency has not had a smooth ride since it was first introduced. USD Investors in Europe, did not do as well, with the initial $1,000,000 investment growing to a bit less than $2 million after 20 years.

Out of this gain, 17% came from capital gains, 65% came from dividends received, and a final 18% from re-investing dividends. So while the stock index did not do well, the dividends have been a source of comfort, accounting for 83% of the total gain!

In numbers:

 2000 to 20202000 to 20102010 to 2020
Total Gain96%18%79%
Annual Return 3.43%1.63%5.27%
From Capital Gain17%-7%23%
From Dividends62%23%34%
From Reinvestment of Dividends17%2%22%

The MSCI EAFE Index of Europe, Australiasia and Far East stocks

What about a more international context? For stocks of developed countries, we can look at the MSCI EAFE index, which covers Europe, Australiasia and Far East. The relevant ETF for this index is the EFA ETF, which was first listed in 2001. Do dividends matter for international investing too?

Investing in the EFA ETF with and without reinvestment of dividends 2001-2020
Investing in the EFA ETF with and without reinvestment of dividends 2001-2020

At first sight, an initial $1,000,000 investment in the EFA ETF shows a similar pattern to an investment in European stocks alone, but the addition of other markets improves the returns initially. However, in the past 10 years from 2010 to 2020, the index itself has not gone anywhere. Over the entire 19 years, the total gain from investing $1,000,000 in the EFA ETF would have been $1.6 million.

Out of this total gain, we see that 38% of it comes from capital gain, 48% comes from dividends, and finally 13% comes from dividends re-invested. Again, dividends play an important part in the overall gains, accounting for 62% of the total gain.

In numbers:

 2001 to 20202001 to 20102010 to 2020
Total Gain163%52%110%
Annual Return 5.21%4.80%5.59%
From Capital Gain62%26%36%
From Dividends79%29%44%
From Reinvestment of Dividends22%-3%30%

The MSCI Emerging Markets Index

Finally, let’s look at international investing, but in developing markets this time. A common index to use for this is the MSCI Emerging Markets index, which was one of the first ways the BRICs – Brazil, Russia, India and China – first came to the world’s attention. The ETF EEM, listed in 2003, tracks this index. What role do dividends play in investing in emerging markets?

Investing in the EEM ETF with and without reinvestment of dividends 2003-2020
Investing in the EEM ETF with and without reinvestment of dividends 2003-2020

Emerging markets had a really strong run in the 2000’s, but there has been little growth in the past 10 years, as the pendulum swung back towards developed market stocks. Still, a $1,000,000 investment in the EEM ETF back n 2003 will have grown into a portfolio worth $4.9 million today, so if you were there at the start, you’d be the richest investor among those who invested in the various markets we have covered here!

Of this investment profit of $3.9 million, 66% of it comes from capital gains, 30% from dividends paid out, and finally miserable 4% from re-investment of the dividends into the EEM ETF. So in the case of emerging markets, capital gain does seem to play a bigger role in returns, which makes sense if the nature of the emerging markets means that there are plenty of opportunities for growth, and hence companies will want to retain their earnings for investment rather than to pay dividends. However, we do see a distinct change between the period 2003-2010, when little was paid out in dividends, and 2010-2020, where far more dividends were paid out. Perhaps many of these markets have indeed emerged!

In numbers:

 2003 to 20202003 to 20102010 to 2020
Total Gain390%263%127%
Annual Return 9.80%20.24%3.04%
From Capital Gain260%227%37%
From Dividends113%35%73%
From Reinvestment of Dividends17%1%17%

Are dividends still relevant for investing?

From a broad overview of investing in stocks in various parts of the world over the past 20 years, the answer is a resounding “Yes”! Even for markets which did not pay much in dividends, such as emerging markets, dividends accounted for a third of all the possible gains from investing over the past 20 years. In more mature markets, where the scope for growth is limited, and hence where companies are more willing to pay dividends, dividends can account for up to 83% of all the possible gains from investing!

Dividends can play an even more important role when investing in retirement as well, as we have shown here, here, here and here, a Yield Shield portfolio does well against Sequence Risk in the early stages of retirement.

In short, our takeaways are:

  1. Dividends have always been a major part of the possible gains from investing, even in recent years, where there is a lot of fascination about growth stocks which do not pay any dividends
  2. Across different markets, dividends, especially when re-invested in the same stocks, have accounted for between 33% to more than 80% of all the possible gains from investing
  3. But investing for dividends does not mean that the investor needs to strictly re-invest the dividends into the same stocks – even if the dividends were saved in a bank account, or used to pay off debt, the majority of the possible gains from investing can be captured already

So don’t worry if you have missed investing in the latest high growth stock! Stay the course and keep collecting those dividends instead!

In our next post, we take a closer look at another investing practice – portfolio rebalancing – and test whether it is indeed necessary. We shall also look further into Dividend Investing: When does it work, and when doesn’t it work?



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