If you are a shareholder, you want two things:
- Capital gains: usually from rising share prices, or
- Dividends: income in the form of a periodic cash return
Why your Superannuation NEEDS dividends
Most people come to the share market for capital gains, that is number one. And it's only after a few years that they begin to realise the power the dividend income.
Some — like me — might get lucky and have some winning investments within the first couple of years on the market. Dividends felt unimportant.
But after a few years, the compounding power of dividends and incremental capital gains makes for a wicked combination.
300% more return from dividends
Everyone knows Australia's share market has been one of the best-performing in the world. In fact, from 1900 to 2016, Australia's 6.7% average annualised return was trumped only by South Africa's 7.3%, according to Credit Suisse. Much of our success is attributed to local companies' propensity to pay high dividends.
To emphasise this point, a study conducted by Dimson, March and Stuanton (2012) on US stock market returns between 1900 and 2012 found that capital gains generated 1.9% per year, on average, in real returns.
However, if reinvested dividends were included in the calculation (i.e. not just capital gains), the US market's real returns would have jumped to 6.2% per year. Just think about that: 6.2% if you include dividends or just 1.9% without.
According to the authors, the absolute return is even more stark with $1 invested for capital gains only growing to around $8.10 by 2012 — including reinvested dividends made it $834.
Not all portfolios are created equal
While Australia's share market has achieved ultra-long-term returns far superior to bonds and even property, not all portfolios are created equal.
We already know dividends are a boon for investors like us.
But imagine all those investors who sold out in the great '27 crash, the ensuing depression, during the World Wars, Cold war, the 87' crash, dotcom bubble, GFC… the list will go on. Clearly, the right temperament is a 'must-have' for successful long-term investing.
Then, there's the old rule of thumb that you should have 100 minus your age in shares — but how many 20-somethings have 80% of their wealth in shares (let alone own the right shares)? Allowing time to compound your returns is imperative. As they say, good things take time. It's important Australians recognise the power of time and start early (even if you can afford just a dollar here or there).
Finally, not everyone should be actively investing. CNN Money reported a few years ago that up to 86% of professional money managers underperformed the market. That means, despite their fees and time committed to studying the markets, they didn't even achieve the market's average.
But here's the kicker: If you cannot devote the time — or simply can't be bothered — that's OK! The market returns I quoted above were very impressive, and they were just the average.
How do you get an average return?
Simple. You can put your money in an index fund like those offered by Vanguard Australia or buy an Exchange Traded Fund (ETF) like the iShares S&P 500 ETF or the iShares Global Consumer Staples ETF, found on Google Finance as ISCS&P500 CDI 1:1 (ASX: IVV) and ISGLCOSTP CDI 1:1 (ASX: IXI), respectively.
They made sound complicated, but they're not. You just buy them like you would any other ordinary share on the market, and what you are getting is exposure to every share in those underlying markets.
For example, say you buy into the iShares S&P500 ETF, the manager of the ETF (iShares in this case) invests the proportionate amount of money in all S&P 500 shares. For a management fee of just 0.07% per year, you can spend as little or as much as you want to get exposure to all shares in the S&P 500 (just imagine the brokerage charge if you had to go out and buy them all yourself!).
And you'll never guess what else: You also get a dividend. The last full-year payment was equivalent to 2.7%. Simply reinvest the dividend, add regularly and hold for the long-term. Rain, hail or shine.
Foolish Takeaway
You may look below this article and notice in my disclosure that I'm not invested in the S&P 500 ETF. I have holdings in other ETFs; that's one reason I don't own it…yet.
Another reason is that I'm actively seeking to outperform the market.
Indeed, I've reserved my portfolio only for those shares that I think have the best chance of outperforming the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) over the long-term.
