Div­i­dends the real deal

That’s why you should be buy­ing shares

Finweek English Edition - - Creating Wealth - SHAUN HAR­RIS shaunh@fin­week.co.za

IT MIGHT BE HARD to be­lieve any­thing good has come out of the past year of tur­bu­lent eq­uity mar­kets. But if there is, it’s the im­por­tance of div­i­dends. Cor­po­rate earn­ings are all over the place, with share prices fol­low­ing. Div­i­dend pay­ments may well be lower in the com­ing year, as Fin­week has pointed out. But div­i­dends are the real deal – and even more pow­er­ful if rein­vested.

Div­i­dends are the rea­son you should be buy­ing shares, older in­vestors will tell you. The prob­lem is that gets so quickly for­got­ten in a bull mar­ket when all the at­ten­tion is on ris­ing share prices. And when we reach bub­ble con­di­tions you’ll no­tice the com­pa­nies with share prices lead­ing the up­ward charge of­ten don’t pay div­i­dends.

To an ex­tent we saw it with some AltX list­ings. It was cer­tainly true in the dot.com bub­ble. When such share prices lose half of their value that’s the hit the in­vestor takes – without any com­pen­sa­tion from div­i­dends.

But for div­i­dends to be an ef­fec­tive part of an in­vest­ment strat­egy it should be longterm in­vest­ing.

An­drew Kemp, head of re­search and in­vest­ment man­age­ment at ac­sis, has con­ducted some re­search to show div­i­dends are one of the most pow­er­ful tools for in­vestors se­ri­ous about a long-term view. “More specif­i­cally, they’d dis­cover the im­por­tance of rein­vest­ing div­i­dends,” Kemp says. His re­search looks at share price changes and to­tal re­turn on the SA mar­ket be­tween 31 De­cem­ber 1960 and 31 De­cem­ber 2008. You can see the re­sult in the graph, show­ing that over time the im­por­tance of div­i­dends (rein­vested as part of the to­tal re­turn) in­creases sig­nif­i­cantly.

Break­ing down the to­tal re­turn shows the power of div­i­dends rein­vested. Over the pe­riod share price changes ac­count for 45,6% of the to­tal re­turn, div­i­dend pay­ments 12,8% – but div­i­dends rein­vested 41,6%.

How­ever, you’ll no­tice it takes time for the to­tal re­turn to start to pull away from share price move­ments – around 20 years in this case. But when rein­vested div­i­dends start to kick in, the dif­fer­ence in re­turns is dra­matic.

How­ever, Kemp points out in­vestors might re­gard the time­frame in his ex­am­ple – al­most 50 years – as be­ing un­re­al­is­tic. “Who has the lux­ury of such a long-time hori­zon?” he asks. While he ac­knowl­edges that’s true, he points to a dif­fer­ent sce­nario. “A 40-yearold with lim­ited sav­ings in­vested 10% of his salary into eq­ui­ties from 1978 un­til his re­tire­ment age at 60 in 1998. His in­vest­ment ob­jec­tive was to re­tire with a pen­sion equal to 70% of his fi­nal salary in or­der to main­tain his life­style.”

Plot­ting that out­come shows – as­sum­ing ex­cess in­come not re­quired to fund liv­ing ex­penses is rein­vested – the in­come gen­er­ated by the port­fo­lio over time grows sig­nif­i­cantly faster than the re­tiree’s liv­ing ex­penses. “Im­por­tantly, the volatil­ity of the div­i­dend in­come is sig­nif­i­cantly lower than the volatil­ity of the mar­ket prices,” Kemp says.

For the re­tiree that will take lots of the angst out of watch­ing share prices go up and down while his port­fo­lio is pro­vid­ing com­fort­ably more than he needs to main­tain his life­style.

Kemp says he’s not sug­gest­ing in­di­vid­u­als should only in­vest in eq­ui­ties. As­set al­lo­ca­tion re­mains im­por­tant and should be done with pro­fes­sional ad­vice. What he’s try­ing to show is the im­por­tance of rein­vest­ing div­i­dends over a long pe­riod. “That’s equally ap­pli­ca­ble to in­vestors who in­vest via unit trusts as op­posed to di­rectly through shares.”

Kemp’s com­ments would ap­ply to most eq­uity or bal­anced unit trust funds. But take a look at how well a unit trust spe­cial­is­ing in div­i­dends has done. The Pru­den­tial Div­i­dend Max­imiser unit trust has been the best per­form­ing over the five years to end-De­cem­ber 2008, of­fer­ing 25,4%/year. It would be dif­fi­cult to find any long-term in­vest­ment re­turn that will beat that.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.