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 per cent.
However, if you include dividends the index has actually returned 122 per cent over the same period (or 4 per cent 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 per cent, not adjusted for inflation or charges, compared with 0.4 per cent 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
This material is not intended to provide advice of any kind. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Past performance is not a guide to future returns and may not be repeated.
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, 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 per cent, although it has averaged around 3 per cent over the last 20 years. The UK stock market currently pays out an average of around 4 per cent in dividends, compared with around 0.5 per cent 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.”
Important Information: The views and opinions contained herein are of those named in the article and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This communication is marketing material.
This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 1 London Wall Place, London, EC2Y 5AU. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.