Thursday, May 14, 2009
By Eric Roseman
The lack of dividends today will probably delay a full recovery for the stock market.
Historically, dividends are responsible for about half of the stock markets’ total return equation.
But in the go-go days of the 1990s, dividends became insignificant as investors lunged after technology and other growth stocks; CEOs ploughed cash back into buybacks at the expense of dividend hikes for the most part. And as the market skyrocketed that decade the dividend yield as a percentage of the markets’ total return shrank.
By 2000, dividends as a percentage of the markets’ total return dwindled to just 10%.
The chart below is probably one of the most telling explanations on why dividends matter…
If an investor bought the Dow Jones Industrial Average at the peak in 1929, he would have waited 29.25 years to break-even or until 1958.
But…with dividends reinvested…the Dow managed to recover its 1929 peak in just 7.25 years! That’s an incredible statistic. But remember, back in 1932 the Dow yielded more than 10%; at the low on March 9, 2009, the Dow yielded just 4.1%.
Right now the yield on the Dow at 3.63% is about 64% lower than it was in 1932. This suggests that stocks could take longer to recoup their October 2007 all-time highs…because the power of reinvested dividends is much less today than back in 1932.
So Where Can You Find Worthwhile Yields?
The big problem with dividend investing today is that many companies are cutting or eliminating dividends altogether.
That’s especially the case with the distressed financial services sector, where dividends have been almost entirely cut or substantially reduced since last year.
Just how the market can recover much quicker without bank dividends – a big chunk of the Dow – remains to be seen.
A better way to ride a recovery…if you feel bold enough…is to buy convertible bonds instead of common stocks.
Your upside, of course, won’t be as snazzy as equities, but at least you’ll have some income to cushion any drawdown. Convertibles suffered their worst year in history in 2008 – crashing almost 40% – but have gained more than 10% in 2009.
My favorite convertible bond fund remains Vanguard Convertible Securities Fund (VCVSX). The Fund has employed the same manager since 1996 and has the lowest expense ratio in the business. In 2009, the Fund has gained 15.5% compared to 1.3% for the S&P 500 Index. Not a bad show.
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Eric is the Investment Director of The Sovereign Society and Editor of Accelerated Income, where he uses proven recession-investing strategies to target boosted returns and capital gains…without the capital risk that goes with stock market investing. He’s just added an investment with a guaranteed yield of 15.79% a year. Click here for more information.