Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services
- The U.S. equity market, represented by the S&P 500 index, slipped 1.2% this week.
- Some sectors of the U.S. equity market generate more of their total return via dividends versus price appreciation than other sectors.
- Ultimately, whether a stock pays a dividend is not the point. The decision to reinvest dividends is what drives compound total returns over time.
Given recent volatility in stock markets, investors may be drawn to more “defensive” sectors of the stock market such as utilities or consumer staples. It is often claimed that the dividend income from those names provides much-needed stability to returns.
Other investors focus almost solely on achieving price returns on equities, seeking capital gains and paying scant attention to dividends. Not all stocks pay dividends, after all, and some have done very well. Warren Buffett’s Berkshire Hathaway is the most famous example of such a non-dividend paying stock.
A note this week from Bespoke Investment Group serves as a good reminder as to why over the medium- and long-term focusing on either approach in isolation has drawbacks. The chart looks at overall U.S. stock market, sector, and fixed-income ETF returns. It shows price return, total return which includes reinvesting dividends, and the percentage of total return achieved from reinvesting dividends.
Chart: Bespoke Investment Group, August 2022
The inception dates are not perfectly aligned, but a few valuable insights may be gleaned. Across equity sectors, it is imperative that the focus be upon total returns and the reinvestment of dividends. Since 1993, the S&P 500 ETF (SPY) returned a total of 10% per year. Almost 45% of that return came from reinvesting dividends. Even in the technology sector, in which companies pay low dividend rates so that they may plow cash flow back into their businesses for growth, reinvesting dividends represented 28% of total return since 1998.
On the fixed income side, investors often flock to preferred stocks and high yield bonds seeking the higher level of income from those asset classes. That approach ignores price risk: the income generated from those ETFs represent well over 100% of their total returns since inception.
Dividend payers are attractive to some investors for their perceived stability. Growth-oriented companies paying meager dividends are attractive to others. Ultimately, whether a stock pays a dividend is not the point. The decision to reinvest that dividend is what drives compound total returns over time.
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