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A picture is worth a thousand words ---- except that sometimes pictures can be misleading! In the "Chart Essays" section we present small nuggets of analysis based on charts or "pictures".

Key concepts:

Chart Essay #3: February 2009

The Impact of Dividends and Inflation on Total Equity Returns

It is in times like these that people notice the positive impact of dividends on equity returns. In fact the lesson applies at all times: over any multi-year period dividends are a crucial component of equity returns. And over the long run dividends and their reinvestment compose the most important component of equity returns.

Figure 1 illustrates this. Using our updated data set taken from Professor Robert Shiller’s website(1), we see that the total return for the S&P 500 index is an impressive 8.712% annualized for the full history from January 1879 to December 2008. “Total return” is the result of reinvesting all dividends back into the index or portfolio. Over the subsequent 138 years, $100 invested on December 31, 1869, with dividends reinvested, would have risen to $10,081,036. By contrast the stock portfolio itself, assuming dividends were spent along the way, returned 3.929% annualized. $100 would have become $20,343, a very nice sum, but 495 times less than the total return.


The second most important component is inflation. Since equities are investments in businesses, and the broad market captures a large part of the economy, we have an expectation that a broadly based equity portfolio such as a market index will grow more or less as the economy grows. Economic growth is a combination of “real” growth and inflationary growth. In Figure 2 we show the S&P Price Index from Figure 1 along with the US Consumer Price Index as our measure of inflation. From 1870 to 2008 inflation logged 2.063% annually, while the S&P Price Index returned 3.929%. In addition we show a third series, the S&P Real Price Index which is the Price index with inflation removed. The Real Price Index return 1.829% annualized, less than inflation.


Inflation has been positive overall, but there are several very long periods (1873 to 1897 and 1920 through 1932) where inflation was generally trending negative. During those periods you can see that the real price index outperformed the nominal index. Conversely, you can see that during the 1968-1981 period, with very high inflation, the real price index is actually very negative over that whole span, while the nominal price index was flat to positive.

Table 1 summarizes these components of the long-run historic return to equities. Just 21% of the return is due to capital appreciation, 24% is due to inflation growth, and 54% of the return is due to dividends and their reinvestment.

Table 1:
Components of Equity Return
1870 to 2008
Total Return 8.712% 100%
Consisting of
(1) Inflation:  2.063% 23.7%
(2) Real Price Return:  1.829% 21.0%
(3) Impact of reinvested dividends:  4.602% 52.8%
(4) Effect of Compounding:***  0.219% 2.5%
*** The compounding effect disappears if we correctly
       multiply the components:  %Total Retrurn =
  (1+%inflation) x (1+%Real Price Return) x (1+%impact of divs) -1

In closing, it is important to point out that the high level of equity returns achieved over this historical timeframe is not necessarily a good indication of what we can expect from equities going forward.


(1) Robert J. Shiller. Irrational Exuberance, 2nd Edition. New York: Doubleday, 2005. Data from his website has been updated using current data sources. (Return to text)