If you ask investors whether steady income or share price growth is more important for long-term equity performance, many might opt for the latter. The reasons for this are obvious, with the tortoise of regular income often eclipsed, in investors’ minds at least, by the hare of doubling your money via the next big stock idea.
In reality, long-term data show the huge impact income can have on investment returns – over the last century, around 75% of the return from UK equities has come purely from the dividend yield according to the well-respected Barclays Equity Gilt Study.
This is often forgotten in bull markets, when investors are chasing big gains in share prices. In the 1990s, for instance, the market was rising sharply thanks to popular technology shares that paid no dividends. Back then, companies that paid out a share of their profits in income rather than reinvesting everything in the business were seen as staid, slow-growing laggards. This soon reversed when the tech bubble burst, when many businesses folded and investors remembered the benefits of solid blue-chip, dividend-paying companies.
Barclays’ annual study shows reinvesting dividends can make a significant difference to overall returns in the long term. An investment of £100 in shares in 1899 would have been worth only £191 in real terms at the end of 2013 based on capital growth in the Barclays UK Equity Index alone. If, however, all the dividends had been reinvested, the total value of the portfolio would have soared to £28,386 over the same period.
The impact of dividends has been greatest over very long periods but it is still significant over the shorter term as well. For example, £100 invested in 2003 would have been worth just £118 in real terms at the end of 2013 (Source: Barclays UK Equity Gilt Study). With income reinvested, the total value would have risen over the same period to £164 – almost 40% more.
Equity income funds can be a good long-term savings vehicle for investors able to tolerate the additional risk, with the potential for capital growth along with the compounding effect we have highlighted.
Source: Barclays Equity Gilt Study 2016