Best of the Week
Most Popular
1. Next Financial Crisis Is Already Here! John Lewis 99% Profits CRASH - Retail Sector Collapse - Nadeem_Walayat
2.Why Is Apple Giving This Tiny Stock A $900 Million Opportunity? - James Burgess
3.Gold Price Trend Analysis - - Nadeem_Walayatt
4.The Beginning of the End of the Dollar - Richard_Mills
5.Stock Market Trend Forecast Update - - Nadeem_Walayat
6.Hindenburg Omen & Consumer Confidence: More Signs of Stock Market Trouble in 2019 - Troy_Bombardia
7.Precious Metals Sector: It’s 2013 All Over Again - P_Radomski_CFA
8.Central Banks Have Gone Rogue, Putting Us All at Risk - Ellen_Brown
9.Gold Stocks Forced Capitulation - Zeal_LLC
10.The Post Bubble Market Contraction Thesis Receives Validation - Plunger
Last 7 days
Silver's Time Is Coming - 17th Oct 18
Stock Market Volatility Breeds Contempt - 17th Oct 18
Gold 7-Year Bear Market Phase Is Over - 17th Oct 18
Gold - A Golden Escape - 17th Oct 18
Tec Stocks Sector Set For A Rebound? - 16th Oct 18
Real Estate Transactions are Becoming Seamless with Blockchain-Powered Data Sets - 16th Oct 18
Important Elements of a Viral Landing Page - 16th Oct 18
Stephen Leeb Predicts 3-Digit Silver and 5 Digit Gold?! - 16th Oct 18
BREXIT, Italy’s Deficit, The EU Summit And Fomcs Minutes In Focus - 16th Oct 18
Is this the Start of a Bear Market for Stocks? - 16th Oct 18
Chinese Economic Prospects Amid US Trade Wars - 16th Oct 18
2019’s Hottest Commodity Is About To Explode - 15th Oct 18
Keep A Proper Perspective About Stock Market Recent Move - 15th Oct 18
Is the Stocks Bull Dead? - 15th Oct 18
Stock Market Bottoms are a Process - 15th Oct 18
Fed is Doing More Than Just Raising Rates - 14th Oct 18
Stock Markets Last Cheap Sector - Gold - 14th Oct 18
Next Points for Crude Oil Bears - 13th Oct 18
Stock Market Crash: Time to Buy Stocks? - 12th Oct 18
Sheffield Best Secondary School Clusters for 2018-19 Place Applications - 12th Oct 18
Trump’s Tariffs Echo US Trade Policy That Led to the Great Depression - 12th Oct 18
US Dollar Engulfing Bearish Pattern Warns Of Dollar Weakness - 12th Oct 18
Stock Market Storm Crash, Dow Plunges to Trend Forecast! - 12th Oct 18
SP500 Stock Market Sell Off Well Forecast by President Trump - 11th Oct 18
USD and US Tr. Yields Retreat, GBP Gains on Brexit-deal Report - 11th Oct 18
Loss Of Yield Curve "Shock Absorber" Could Mean A Rough Ride Ahead For Markets & Housing - 11th Oct 18
Just How Bearish is the Stock Market’s Breadth? - 11th Oct 18
Here’s Why Gold Stocks, Gold, and Silver Are Great Buys Now - 10th Oct 18
Russian Ruble Technical Chart Analysis and Forecast - 10th Oct 18
Society Trends To Keep in Mind in the USA - 10th Oct 18
[eBook] How to Identify Turning Points in the Market - 10th Oct 18

Market Oracle FREE Newsletter

Trading Any Market

Stock Market Returns – The Wonder of Compounding Dividends

InvestorEducation / Dividends Jul 25, 2008 - 07:33 AM GMT

By: Prieur_du_Plessis

InvestorEducation

Best Financial Markets Analysis ArticleAlbert Einstein described compound growth as the eighth wonder of the world. Although he may have passed away in 1955 – coincidentally the year when yours truly saw daylight for the first time – the concept of compounding remains the single most important principle governing investment.

Back to basics: Compounding simply means that you can earn interest on your principal investment amount, as well as earn interest on top of interest. The power of compounding can make an investment grow much faster than would otherwise have been the case, and is obviously based on the assumption that interest or dividends are reinvested in the same asset.


The raison d'être of investment or wealth management is to maintain, or hopefully improve, one's standard of living, i.e. to earn a real return on the investment amount. This sounds easy enough if one considers that the S&P 500 Composite Index (and its predecessors) delivered a nominal return of 9.1% per annum from January 1871 to May 2008. With an average inflation rate of 2.2% per annum over the period, this meant a real return of 6.9% per annum.

These figures may not particularly appeal to many of today's market participants with their gun-slinging approach. I am deliberately refraining from using the word “investors” and can hear these people arguing that much better returns can be generated by “playing” the market cycles. Ah, the art of market timing! Perhaps, but keep in mind that very few people have succeeded in consistently outperforming the market over any extended period of time, especially once costs and taxes are factored in.

More compelling proof that the odds are stacked against the capital-growth-only brigade is gleaned from an analysis of the components of the total return figures. Let's go back to the total nominal return of 9.1% per annum and see how that was made up. We already know that 2.2% per annum came from inflation. Real capital growth (i.e. price movements net of inflation) added another 2.1% per annum. Where did the rest of the return come from? Wait for it, dividends – yes, boring dividends, slavishly reinvested year after year, contributed 4.7% per annum. This represents more than half the total return over time!

Still doubting the evidence? Have a look at the following chart:

And for good measure, here are the numbers summarized in table format.

Source: Plexus Asset Management (based on data from Prof Robert Shiller and I-Net Bridge)

In an environment characterized by increasingly shorter investment horizons, the concept of compounding sounds so yesteryear, but who can argue with the body of empirical market evidence? To coin a phrase often quoted, but seldom fully appreciated (or understood): It is time in the market, and not market timing that counts.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

By Dr Prieur du Plessis

Dr Prieur du Plessis is an investment professional with 25 years' experience in investment research and portfolio management.

More than 1200 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns (including his blog, Investment Postcards from Cape Town : www.investmentpostcards.com ). He has also published a book, Financial Basics: Investment.

Prieur is chairman and principal shareholder of South African-based Plexus Asset Management , which he founded in 1995. The group conducts investment management, investment consulting, private equity and real estate activities in South Africa and other African countries.

Plexus is the South African partner of John Mauldin , Dallas-based author of the popular Thoughts from the Frontline newsletter, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

Prieur is 53 years old and live with his wife, television producer and presenter Isabel Verwey, and two children in Cape Town , South Africa . His leisure activities include long-distance running, traveling, reading and motor-cycling.

Copyright © 2008 by Prieur du Plessis - All rights reserved.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Do your own due diligence.

Prieur du Plessis Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Retail Investor
05 Oct 08, 17:55
Misrepresentation of the dividend growth

You misrepresent in two ways.

The most egregious is that ubiquitous graph. It does NOT prove Shiller's conclusion. The large blue area labeled as the portfolio's value attributable to dividends does NOT come from dividends. See the proof at:

http://members.shaw.ca/RetailInvestor/truths.html#dividend60%return

The second is your calculation of the 'real' returns from capital appreciation vs the return from dividends. Inflation's effects were subtracted from ONLY the capital appreciation. Thereby leaving the impression that dividend returns are much larger.

Inflation hits all income from all sources.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules