The stock market is jittery. We could end 2018 with more losses in the major indices and continue the pessimism into 2019.
However, every downturn gives investors the opportunity to buy great companies cheaply. And a measure of cheapness is the dividend yield – the higher the dividend yield of a stock, the cheaper it is, with all things being equal.
Dividends are powerful when they are used in the right way – which is to re-invest them.
The power of dividend reinvestment
Jeremy Siegel, a famed finance professor, referred to reinvested dividends as the “bear market protector” and “return accelerator”. He explained (emphases are mine):
“There are two important ways that dividends help investors in bear markets. The greater number of shares accumulated through reinvested dividends cushions the decline in the value of the investor’s portfolio. It is because of additional shares purchased in down markets that I call dividends the ‘bear market protector.’ These extra shares do even more than cushion the decline when the market recovers. Those extra shares will greatly enhance future returns. So in addition to being a bear market protector, reinvesting dividends turns into a ‘return accelerator’ once stock prices turn up. This is why dividend-paying stocks provide the highest returns over stock market cycles.”
By re-investing dividends at when the shares are still cheap, we own more of a company, and we receive more dividends as those new shares pay dividends as well. It becomes a virtuous cycle and this drastically accelerates shareholder returns. This is the case historically as well.
From 1960 to 2017, 82% of the total return of the S&P 500 index, a major stock market index in the US, can be attributed to reinvested dividends and the power of compounding, as seen in the chart below:
In Singapore, we don’t have a history going back that long, but there are similar themes.
Using data from the website of SPDR STI ETF (SGX: ES3), an exchange-traded fund that tracks the fundamentals of the Straits Times Index (SGX: ^STI), since 2002, the STI ETF has given a total return of 195.04%. Without dividends, the return falls to 79.11% during the same period. By doing some quick calculations, we would realise that dividends accounted for more than 50% of the total return. That’s the power of dividends and re-investing them for the long-term.
DRIP, DRIP, DRIP
Dividend reinvestment can be done by signing up for a dividend reinvestment plan (DRIP) if the company you have shares in offers it. DRIP allows investors to reinvest their cash dividends into additional shares of the company at a certain price, without any commission.
If the company doesn’t offer DRIP, you can accumulate the dividends received from your shares in a separate bank account. You can then invest in more shares when the dividend-amount becomes significant to render commission charges negligible.
The Foolish takeaway
Dividends have played a significant role in enhancing total shareholder returns.
Going into 2019, re-investing our dividends may be what our portfolio needs to serve as a bear market protector. Those re-invested dividends should go on to accelerate our portfolio returns when the stock market recovers in time to come.
Attention Singaporean Investors: We’ve just released our latest investing project - Stocks 2019. It comes with David Kuo’s bold 2019 predictions, an investing “Tactical Handbook” and 12 stock ideas that we think will take abuse from the uncertain market. But you’ll have to hurry because Stocks 2019 will be gone after midnight. And we are not sure when it’ll be back. Click here to find out how Stocks 2019 can help you to invest next year.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.