The story of the FTSE 100 over the last 20 years is a compelling argument for reinvesting dividends.
As revellers saw in the new millennium on New Year’s Eve 1999, the FTSE 100 closed at a then-record high of 6930.
The stock market was in the grip of the “dotcom” boom. They were good times for many investors. But few could have envisaged then what would happen over the next two decades.
First, the bursting of the dotcom bubble at the turn of the millennium, then the global financial crisis, which began in 2007, wiped billions off the stock market. It took years to recover. Subequently, geopolitical events such as Brexit have continued to stifle the FTSE 100.
By 31 December 2019, exactly 20 years on, the FTSE 100 would barely have moved. It stood at 7542, just over 600 points higher. Price-wise, that’s an average annual return of 0.4%.
However, if you include dividends the index has actually returned 122% over the same period (or 4% a year), according to Schroders’ calculations.
The dividend reinvestment effect
We have crunched the numbers.
As the chart below shows, if you invested £1,000 into the FTSE 100 on 31 December 1999 and left it alone, it would be worth £1088 without reinvesting dividends. That’s not adjusting for the effects of inflation or charges.
It also does not include the value of taking dividends as a cash payment. That’s because when you take the dividend as cash payment there is no guarantee you will reinvest it. You could use it to supplement your monthly income, for example.
However, the picture changes dramatically if you had invested in the FTSE 100 and opted to revinvest the dividends its listed companies pay.
In this scenario, if you had invested £1,000 in the FTSE 100 on New Year’s Eve 1999, your investment could now be worth £2,222. That’s an annual return of 4%, not adjusted for inflation or charges, compared with 0.4% if you had invested in the index alone.
Ideally, stock prices should rise too, so your capital grows along with your income. But as the data shows, even when the actual price of the index barely moves, you can still earn a return on your investment if you reinvest company dividends.
The green bars in the chart below show the theoretical investment return had you reinvested your dividends. The blue bars show the return without dividends reinvested.
FTSE 100 returns with and without dividends 1999-2019
Source: Schroders. Refinitiv data for FTSE 100 correct at 13 January 2020. Returns not adjusted for inflation or charges.
What are dividends?
Dividends are a form of income paid out by companies to investors.
Dividend payments make up an important part of an investment’s total return, which includes capital growth.
Dividends can be taken as a cash payment or reinvested to buy more shares.
If you opt for the latter, it enables you to benefit from the effects of compounding or what Einstein called the “eighth wonder of the world”.
Compounding enables you to earn returns on returns and can help your money grow faster.
Sue Noffke, Schroders’ UK Equities Fund Manager, said:
“As the data shows, reinvesting the dividends companies pay can make a significant difference to the value of your investment. Of course, there’s no guarantee that your investment will rise in value over time.
“Dividends are an important part of an investor’s portfolio, especially with bond yields near historic lows. And inflation is currently around 2%, although it has averaged around 3% over the last 20 years. The UK stock market currently pays out an average of around 4% in dividends, compared with around 0.5% for UK government bonds.
“It is one of the reasons we always advocate a long-run approach to investing. It’s also why dividends are often said to account for the majority of returns from the stock market over the long-run.”
“Dividend reinvestment is a simple technique. Over time, those seemingly small amounts reinvested can grow into much bigger sums if you use them to buy even more shares that pay dividends in turn.
“Investors need to do their research and make sure the company they are investing in can afford to pay their dividends on a sustainable basis. Your original capital is also at risk, so it pays to be picky.”
The above article was previously published by Schroders on 18th February 2020