The rewards of dividends

When share market volatility rises, more investors would make the mistake of concentrating too much on short-term movements in share prices.

Yet investors should never overlook that share-market returns are from both capital growth and dividends. Historically, dividends have made up a large proportion of the total returns from Australian shares.

Post-GFC dividend rewards

An illustration of how much dividends can contribute to total share returns is the performance of the Australian share market since the global financial crisis (GFC).

Once reinvested dividends are taken into account, the performance of the Australian share market following the GFC looks much stronger – even before allowing for franking credits on dividends:

  • The S&P/ASX 200 index (prices only) closed on March 13 this year almost 10 per cent below its pre-GFC closing high (reached in November 2007) yet 96 per cent above its GFC closing low.

  • By contrast, the S&P/ASX 200 total-return index (share prices plus reinvested dividends) closed on March 13 this year 50 per cent higher than its pre-GFC high.Critically, this total-return index is 205 per cent above its GFC low.

Grossed-up dividends

Franking credits – tax credits for corporate tax already paid by companies – make a valuable contribution to returns from Australian shares that investors may sometimes overlook. A fully-franked dividend of, say, 4 per cent grosses up for franking credits to 5.71 per cent.

Compounding dividends

The disciplined reinvestment of dividends – if possible, given an investor’s financial circumstances – magnifies their rewards. As Smart Investor regularly discusses, compounding occurs as returns are earned on past returns as well as your original investment.

Dividends as a volatility cushion

Your dividends can act as a volatility cushion. This is because dividends keep flowing from a diversified share portfolio as share prices fluctuate.

Dividends and your long-term focus

A way to help block out the distraction of daily movements in share prices is to remind yourself about the two sides to share-market returns, dividends and capital gains. This should assist you to remain focused on your long-term goals.

Dividend-chasing trap

While recognising the contribution that dividends make to an investor’s share-market returns, don’t fall into the trap of abandoning a carefully-constructed, well-diversified share portfolio in the pursuit of higher dividends. Being a dividend-chaser often involves investing in higher-risk, more-concentrated share portfolios.

Total-return investing

Finally, think about taking a total-return approach to investing for your overall investment portfolio. Total-return investing focuses on both the income and capital growth generated by an overall portfolio.

This approach should help maintain a portfolio’s diversification, allow more control over the size and timing of eventual portfolio withdrawals upon retirement, and increase a portfolio’s longevity.

Please contact us on 03 9770 6499 if you seek further discussion on this topic

Source : Vanguard 

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