Investing like a Nobel Prize winner

Albert Einstein loved it so much he described it as the eighth wonder of the world. Richard Thaler thinks it is at least as important as trigonometry and therefore should be taught in schools.

Both have won a Nobel Prize – one in 1921 the other 2017 – so perhaps we ordinary folk should take note.

The are, of course, talking about compound interest. Very simply, this is ‘interest on interest’: if you reinvest any interest or dividends you receive from your investments, it will boost your pot of money and, in turn, earn you more interest in the future.

Never has this been more apparent than in the chart below, which was brought to our attention by the team at Matthews Asia.

It shows the performance breakdown for six major world stock markets over the past 20 years – highlighting the difference between the price returns and the total returns (when dividends have been reinvested).

As you can see, almost all of the returns from the UK stock market since the turn of the millennium have been from dividends. If you hadn’t reinvested, your capital would be roughly the same as it was on 31 December 1999 (just 2%* higher). With dividends reinvested, the total returns were 103%*.

Cushioning market falls

Shorter term, the reinvestment of dividends can be just as useful. As the managers of Elite Rated Artemis Income pointed out recently: “That 2018 is over is probably the best that can be said about it. After having spent much of the year watching Wall Street’s exuberance from the sidelines, UK investors were engulfed in the aftermath of its collapse, as share prices here followed the US market lower.”

The UK stock market fell 12.62%** over the calendar year, but if investors had reinvested their dividends, the fall was a slightly more palatable 8.82%**.

While Brexit is still causing a lot of uncertainty in the UK and our stock market is very much out-of-favour with overseas investors, the average yield is around 4.8% – the highest level in a decade***. So even if the price return is negligible in the coming year, there is still a decent amount of income that can be earned.

Global dividends just as powerful

While the UK has the most extreme difference between returns over the past two decades, the same pattern can be seen in the other five major world stock markets.

Europe would have disappointed investors choosing not to reinvest, with price returns of just 27.71%* compared with total returns of 113.27%*. With a yield of 4.56%, Elite Rated BlackRock Continental European Income fund looks specifically for companies with sustainable dividend payments. Manager Andreas Zoellinger says that, while the fund’s strict criteria does not change, the companies in which he invests will change over the economic cycle to make sure the fund’s dividend is reliable.

Japanese equity returns are also almost entirely down to reinvested dividends (7.29%* compared with 42.11%*) – quite a feat for a country that has, until recently, not been known for rewarding shareholders in this way. The dividend culture in Japan has been much slower to realise than the UK, but is improving at a faster rate today, thanks to Prime Minister Abe’s focus on improving corporate culture and the treatment of shareholders.

Indeed, the change is such an exciting one that Baillie Gifford have recently launched a fund to profit directly from this theme: As more and more businesses move towards a progressive dividend-paying policy, Elite Radar fund Baillie Gifford Japanese Income Growth aims to benefit from the improving corporate governance in Japan.

Asia, and China in particular, have experienced phenomenal growth over the past two decades, so at first glance, their price returns look very respectable: 133.71%* and 181.44%* respectively. But here too, dividends have played a significant role: total returns are 263.47%* for Asia ex Japan and 355.76%* for China.

While Schroder Oriental Income investment trust hasn’t been around quite as long as 20 years (it was launched in 2005), it is an obvious option for investors looking to tap into the Asian dividend theme: it has a yield of 4.1% and the ability to use gearing to enhance capital returns (please not gearing can also increase the risk of losing more money when markets fall).

On a global scale, dividends last year were very strong. More and more companies are seeing the benefits of returning money to shareholders and we at FundCalibre believe this trend will continue.

This is very positive for investors – both those seeking an income today to perhaps supplement their retirement, or those investors wanting to reinvest their income and enjoy the compounded returns it will bring in the future.

*Source: FE Analytics, price and total returns in sterling, 31 December 1999 to 21 January 2019
**Source: FE Analytics, price and total returns in sterling, calendar year 2018.
***Link Asset Services, dividend monitor, January 2019

The views of the author and any people interviewed are their own and do not constitute financial advice. However the knowledge that professional analysts have analysed a fund or trust in depth before assigning them a rating can be a valuable additional filter for anyone looking to make their own decisions. Before you make any investment decision make sure you’re comfortable and fully understand the risks. If you invest in fund or trust make sure you know what specific risks they’re exposed to. Past performance is not a reliable guide to future returns. Remember all investments can fall in value as well as rise, so you could make a loss.