Wednesday, February 12, 2020

Index Investors are Closet Dividend Growth Investors

Last year marked a record in earnings and dividends for US companies. The S&P 500 index ended up distributing a record number of dividends as well.

As a result, the S&P 500 has managed to increase annual dividends for ten years in a row. This makes the S&P 500 a dividend achiever. This means that every index investor who owns shares in a mutual fund following S&P 500 or the Total US Stock Market is a closet dividend growth investor. In a previous article I stated that I find those funds to be the best dividend ETFs for investors in the accumulation phase of their journey.

The growth in dividends per share was supported by growth in earnings per share. Those hit a record as well.

As a dividend growth investor, I look for investments that can deliver rising dividend income over time. I want dividend growth to be supported by growth in earnings per share, which provide the fuel behind future distribution hikes. Dividend income is more stable than capital gains, which makes it an ideal source of income in retirement. The stability and dependability of those dividend checks is the main reason retirees have been building portfolios to pay for their retirement.

It is great that index investors are enjoying the same benefits of long-term investment that dividend growth investors are enjoying as well.

Long-term expected returns on equities depends on three factors:

1) Initial dividend yield
2) Earnings and dividend growth
3) Changes in valuation

This is the formula that Jack Bogle wrote about in one of his books. I respect this giant in investing tremendously, and was deeply saddened by his demise in early 2019… Once I read his book on mutual funds, I realized that dividend growth investors and index investors are not that different at all.

We both look for low costs, low turnover, and being as passive as possible in taking the full power of compounding working for us. We both can benefit, as dividends are the investors' friend.

After S&P 500 has become a dividend achiever, it looks like any fund or investor who essentially owns this fund is a closet dividend growth investor. I am hopeful that more investors embrace a strategy for generating dividends, and that they would love the tax advantaged source of income. With dividend growth investing, you are likely to receive raises that are higher than the rate of inflation and higher than raises at most companies these days. I do not believe that anyone is so dumb as to state that they would hate receiving raises above the rate of inflation or above the rate you would get at most jobs in the US. More income beats having less income. Receiving passive dividend income from my investments beats earnings a salary by working 50 hours/week and commuting 10 hours/week come rain or shine. Passive dividend income also grows faster than active employee income.

The way to invest in the S&P 500 is through a low cost mutual fund, such as the one from Vanguard. It is available as an ETF with a ticker VOO. Alternatively, it is available through a mutual fund, with a ticker VFIAX. The oldest ETF on S&P 500 is very popular, and has the ticker SPY.

If you look at the Vanguard Total Stock Market Index ETF (VTI), it also has a ten year history of annual dividend increases. It is available as an ETF with a ticker (VTI). That’s an impressive track record:

It appears that the S&P 500 is a good dividend growth stock, which is well diversified. I view investing in S&P 500 as similar to buying a diversified conglomerate, such as Berkshire Hathaway. If the only way to invest was through a 401 K, I would strongly endorse that.

The US stock market is comprised of companies with established culture of raising dividends annually, like clockwork. This is a different culture than the one in many companies outside the US. However, this is not only because of culture. Most US companies have a dominant position on a global scale, which makes them the envy of the world. The US has a system which unleashes human potential, which is why the US has an economy that is a leader in innovation. That’s how the US has managed to generate a quarter of the World’s Economic Output with just 5% of the world’s population. The strong market economy, the democracy and the rule of law makes it a great place to invest. Not surprisingly that’s perhaps the reason why the US accounts for almost half of global market capitalization, given the fact that it houses only 5% of the worldwide population.

If you look at the history of annual dividends on the S&P 500 since 1960, it looks like this is not the first time that the index has developed an outstanding record of annual dividend increases. Between 1971 and 1999, the companies in the S&P 500 increased annual dividends per share every year. This brought dividends per share from $3.16 to $16.69, and had turned the S&P 500 index into a dividend aristocrat by 1996.

The S&P 500 dividends per share dipped by a little in 2000 and 2001, to $16.27 and $15.74/share. This could have been not only due to the recession, but also due to the inclusion of tech companies with no earnings in late 1999 and early 2000. In comparison, the price of the S&P 500 dropped by over 50% between its high in the year 2000 to its low in the year 2003. This is why dividend payments are more stable and reliable than capital gains and share prices. This is why it is wise for retirees to live off dividend income in retirement, rather than follow the foolish advise of selling stock at low prices.

By 2008, S&P 500 had managed to grow dividends for 7 years in a row to a high of $28.39. In 2009, the dividend cuts resulted in dividends declining to $22.41.

While dividend payments fell by 21% as a result of the worst recession since the Great Depression in the US, Stock prices fell by more than 50% from their high in 2007 to their lows in 2009. This is why dividend payments are more stable and reliable than capital gains and share prices. This is why it is wise for retirees to live off dividend income in retirement, rather than follow the foolish advise of selling stock at low prices.

Everyone proclaimed dividend investing to be dead, yet surprisingly this was the ideal ground to invest in dividend stocks. As I discussed before, the dividend aristocrats had done very well during the next 12 years. And as a result of the economic rebound, growth in earnings and free cash flows, the S&P 500 was able to grow dividends for 10 years in a row from the ashes of the Global Financial Crisis.

Due to rising annual dividend payments from US corporations over time, I view market indexes such as S&P 500 or Total US Stock Market index to be some of the best dividend growth ETF’s for investors. As I mentioned above, I simply view these funds as similar to one large diversified conglomerate with several hundred subsidiaries. If an investor managed to put money to work every month, and invests for the long-term, they should do well for themselves. If I were investing in a fund however, I would not sell after a dividend cut, due to the diversified nature of the portfolio. I usually sell after a dividend cut for individual holdings that I manage in my dividend portfolio, but would not do that for a fund on S&P 500 or Total Stock Market index.

And since there are several trillion dollars that are passively invested in S&P 500 and Total US Stock Market index, it would seem that Dividend Growth Investing is one of the most popular investment strategies out there.

Welcome to the Dividend Growth Investor Community Index Fund Investors! Glad to have you on-board!

Relevant Articles:

Dividends Are The Investors' Friend
John Bogle Likes Dividends
Dividends Provide a Tax-Efficient Form of Income
What Dividend Growth Investing is all about?

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