Learn to Love Dividends

When investing in shares there are two ways in which we make a return.

Firstly, we make income or a yield from dividends.

Secondly, if the capital value of a share goes up and we sell for a greater price than our cost, we make a capital growth.

Unfortunately, most investors, and many commentators focus almost myopically on capital growth, and often forget about dividend income or yield. Every evening we are bombarded with “the all ordinaries has gone up by (or lost) x points today because of (insert random reason here)..”

The real value of an investment is the ability for it to produce an income. When people buy businesses, they decide on the amount they are willing to purchase it for, based on the businesses ability to make a profit.

Inexperienced investors enter a market after they have seen healthy price increases, thinking that those increases will continue into the future. In reality, healthy price increases mean someone has already made a profit – it may be too late to buy now as all you are doing is fuelling prices higher. They will then often get burnt as prices fall and then get out at a loss, complaining that it was just their rotten luck that the time was not right to get in.

Experienced investors buy more when prices are down because they can buy income-producing assets at a relatively lower price. They will then either hold on to them for long term profit or sell them to the inexperienced investors (at a nice profit thank you very much) when prices go up.

By focussing only on the changes in price we miss a lot of the point of investing – to purchase income producing assets.

Since 1900, about half of the returns from Australian Shares has been from dividends.

For the last 30 years, the All Ordinaries Index has provided a compounding Capital Gain of about 5%. This means you would have turned $10,000 to about $45,000 over that period.

If you include dividends, the compounding return was about 9%, and your $10,000 would have increased to about $140,000 – almost $100,000 more that the gain alone.

By investing solely on the ‘if’ of a capital increase, without considering the income producing ability of an asset, we are speculating, and it is speculation which causes the boom and bust of property and share markets.

When investing in growth assets, give due consideration to yield, not just capital growth.