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Show Me the Money...

By Mike Minter, CFP®

Over the past 18 months, the stock market has lost roughly 50% of its value. 

Obviously, this has created a lot of concern and what makes things even more confusing is that many financial professionals all have different opinions on what will happen next. 

One that I hear frequently is, “the markets are half the price they were so now is a great time to be invested since the markets tend to grow about 10% a year on average”. 

On the other side you hear, “earnings are dropping fast and there is so much uncertainty that cash is king.” 

Both approaches make some sense, but if you listen to one and not the other, it could significantly affect the returns of your portfolio.  So since no one has a crystal ball and it is almost impossible to pick market bottoms, what should you do?

This is a tough question to answer since over the short-term markets can do anything, depending on a lot of different factors.  But what I will say is that, historically, you have a better chance of building wealth when the stock market is willing to pay you.  For the Jerry Maguire fans out there…“Show me the money”! 

What am I talking about?  One word…Dividends

I will get to how dividends impact a portfolio over time later, but for now let’s focus on dividend yields.  Since 1926 until now, the average dividend yield on the Standard & Poor’s 500 index (S&P 500) was approximately 3.7% and usually stayed in a range between 2.87% - 5.56%. 

What is interesting to me is that when you look back at some of the best times to invest in the stock market (1933, 1942, 1975 & 1982), the dividend yield was at or over 5.56%.  You were actually getting paid an attractive yield on your investment at a time when stocks were getting ready to appreciate.   

Conversely, when you look back at some of the worst times to have money invested in the stock market (1929, 1937, 1966, 2000 & 2008), the dividend yield was below the 3.7% average, and sometimes it was under 2.87% which is at the lower end of the range.  The yield being offered was low and stocks either didn’t move higher or lost money.    

Think about it.  If a stock was appreciating while paying a small dividend or none at all, why would the company decide to pay or increase them?  There wouldn’t be a shortage of buyers in the market and shareholders would already be happy with their gains. 

On the other hand, when company stock prices aren’t moving up or are losing value, increasing dividends is a great tool.  Not only does it give existing shareholders an incentive not to sell the stock, but it also attracts new investors in the company.   

In late 2007, dividend yields were roughly 2%.  This was under the lower end of the range referred to above (the dividend yield was trying to warn us), and since the start of 2009, the dividend yield was close to the historical average of 3.7% (this was more a case of stock prices falling rather than dividends increasing).  The problem with the 3.7% number is that since the start of 2009, companies in the S&P 500 have cut more than $40 Billion of their collective dividend stream.  This is already a quarterly record with a few weeks to spare.  If you go back to September 2008 (before things really started getting bad), the reductions have exceeded $64 Billion.  I’d be a much bigger believer in this current rally if this were not the case.

Now let’s go back and look at returns of the S&P 500 with and without dividends.  If you go back to 12/31/1929 through 2/28/2009, the return of the S&P 500 without dividends was 4.6%.  When you include dividends over that same time period, you get a return of 8.8%. 

Let’s look at it another way.  If you invested $100 in the S&P 500 on 12/31/1929 and didn’t include dividends, you would have $3,427 on 2/28/2009.  Now that same $100, invested on the same date, which include dividends that were reinvested, you would have $79,655 on 2/28/2009. 

Bottom Line...

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