What the S&P 500 can teach us about reinvested dividends | Smart Change: Personal Finances
The S&P500 is by far the most followed index on the stock market. In tracking the 500 largest U.S. public companies by market capitalization, the performance of the S&P 500 is often used interchangeably with the performance of the stock market as a whole. There are many big lessons to be learned from the S&P 500, but few are as important as the power of reinvested dividends.
The S&P 500 often reigns supreme
Since its inception in 1957, the S&P 500 has consistently delivered long-term returns that few stocks have come close to replicating. In fact, the S&P 500 has become the norm to the point that when professional investors on Wall Street raise funds, they often do so in the hope of outperforming the S&P 500. Despite all the data and technical resources at their disposal, the most fail to do so. so in the long run.
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Warren Buffett bet $1 million to a hedge fund manager that the S&P 500 would outperform a group of hedge funds over a decade, and by year nine the S&P 500 had posted cumulative returns (total returns over a set period) 85.4% while the average cumulative return of hedge funds was 22%. Three of the five funds tracked against the S&P 500 had cumulative returns of just 2.9%, 7.5% and 8.7% at that time.
You can thank the dividends
The important role of dividends in total investor returns is often underestimated. This is especially true when using a dividend reinvestment program (DRIP). A DRIP takes dividends paid to you and automatically reinvests them in the stock that paid them. For example, if you receive a quarterly dividend of $25 from a fund, the payment will be used to purchase $25 worth of stock. Even with seemingly low dividend payouts, they can make all the difference over time as they add to the cumulative effect.
Nowhere is the power to reinvest dividends more prevalent than with the S&P 500. Disregarding dividends and just stock price, a $10,000 investment in the S&P 500 in 1960 would have been worth more than $795,800 at the end of 2021. If you look at the total return of the S&P 500 from 1960 to 2021 with dividends reinvested, a $10,000 investment would be worth just under $4.95 million.
In other words, over the past 60 years or so, reinvested dividends and compounded earnings have accounted for 84% of the total return of the S&P 500.
Patience will reward you
One of the best things you can do is reinvest your dividends until retirement and then start receiving them as cash payments for supplemental income. The “small” dividend payouts won’t make too much of a difference if you receive them in cash along the way, but if you reinvest them and let the compounding gains work their magic, they can pay off big in retirement.
Historically, the S&P 500 has returned around 10% per year over the long term. Say it has a constant dividend yield of 2.5% and you invest $1,000 per month in an index fund for 20 years at those yields. Here is the difference between the account totals between no dividend and reinvestment of the 2.5% dividend yield:
|Monthly fee||Average annual return||Account total after 20 years|
|$1,000||12.5% (dividend included)||$916,300|
By simply reinvesting dividends over this period, you can accumulate approximately $229,000 more. With $916,000 in an index fund paying a 2.5% dividend yield, that’s $22,900 in annual dividend payouts. It may not be enough to get you through retirement, but it’s definitely a great source of income.
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