Dividends , Portfolio , Retirement


I am purposely trying to be as dramatic as possible with the title of this post without distorting its meaning. This post is another in my series of dividend posts trying to emphasize just how important dividends are to investor stock returns. To that end I recently ran across a GMO paper by James Montier that highlights this perspective very well (Hat tip to Mebane Faber at World Beta ). Lets get to that paper and lets the great charts do the talking.

First, Montier dives into the critical issue of holding period. Turns out the average holding period for US stocks has declined dramatically over the last several decades. See chart below.

Then Montier points out how the sources of stock returns change when your holding period, time horizon, changes from 1 year to 5 years. See chart below. All return stats in the charts below are real returns.

Wow! So if you invest with a 1 year time horizon, close to 80% of stock returns are due to changes in valuation. With a 5 year horizon close to 80% of your returns are due to dividends. When I saw this chart I saw the legendary Ben Graham (of Graham-Dodd) reciting his famous investing axiom, ‘in the short term the market is a voting machine, in the long term the stock market is a weighing machine’. Patience and perspective are truly rewarded over the long term. What about the really long term? Montier’s next chart tackles S&P returns since 1871.

Since 1871 dividends, current yield plus dividend growth, have accounted for 90% of US stock market real returns! This chart also shows the impact of a bull market and the start of a bear market on returns. As an aside, one of the reasons I like individual stocks over the indexes at this point is the low current yield of the SP500. As history shows, dividend yield, is a major component of historical return. More on this topic in future posts.

Finally, this is not just a US phenomenon. The importance of dividends holds world wide and they account for 80-100% of country stock returns in this time period. This last chart uses world wide returns going back to the 1970s.

One other point I’d like to make. The importance of dividends in its two forms, dividend yield and dividend growth, has nothing to do with whether the investor is saving for retirement or is actively in retirement. Over the long term they are very important to both investors. Over shorter time periods dividends are even more important for retirees who have the requirement of making yearly portfolio withdrawals.

I highly recommend that you read Montier’s paper in full, at least the first half. The second part of the paper discusses a new financial derivative being used in Europe, dividend swaps. The part of the paper is for true investing geeks like me. Actually, anything written by GMO is worth a read. The web site requires registration but its well worth it.

Here is to all of us having the patience and the long term perspective to realize the power of dividends in long term compound returns. Walking the walk is a lot harder than talking the talk.