Dividends vs. Inflation

This week we hosted a Fifty Years, Three Bear Markets: Some Investing Lessons from History seminar.  The first part of the seminar compared three of the largest stock market declines to help put today’s investment landscape into context.  The second part of the seminar discussed how we use that information when building out a retirement income plan. 

Here is the complete slide deck for those who are interested. 

Rather than recapping the entire seminar, today I just want to focus on one item that often goes overlooked. And that is the power of dividends. In previous notes I’ve written that total return is more important than dividend income for retirees. And that continues to be true.  But dividends, specifically those of the great companies in America and the world, have proven to be the most powerful yet completely effortless way for retirees to keep their income growing far ahead of what inflation takes away. I would argue that dividend growth is the most underappreciated phenomenon in equity investing, except compounding itself.  

To give you an example of what I mean, since 1960, despite everything you have heard about inflation eroding your purchasing power, the cash dividend on the S&P 500 is up roughly 35 times versus 10 times for inflation.     

To put these numbers into perspective, if you were getting a dividend of $19,800 from a hypothetical S&P 500 index fund in 1960, you would have to receive roughly $190,800 per year by 2023 to maintain the same spending power.  That seems like a huge climb until you realize the same shares of the same hypothetical S&P 500 index fund would now be paying a dividend of roughly $703,000 per year.

And that is only the dividend portion. As this next slide makes clear, if you had invested $1,000,000 into the same hypothetical S&P 500 index fund and were spending your dividends, (which is what a normal stock chart infers when it just shows the change in value from point A to point B) your $1,000,000 is now worth $81,000,000. Not too bad but if you were reinvesting the dividends along the way, you would now have $508,000,000. 

For comparison, a retiree that invested $1,000,000 into a 60-year bond would still have the same cash flow today that he had in 1960 and the principal, although still a nominal $1,000,000, would have lost roughly 90% of its spending power. 

While there continue to be no facts about the future, and past performance is not indicative of future returns, it is always worth repeating: How much risk you are taking is entirely dependent on how you define risk. When risk is defined by day-to-day volatility, bonds seem safe, and stocks seem risky. However, if we define risk based on the likelihood of maintaining spending power over the course of a 30+ year retirement, bonds no longer seem so safe, and stocks no longer seem as risky.