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Market View

In addition to the prospect of attractive current income, dividends also may offer investors the potential for solid income growth.

As we discussed in the October 20, 2014, Market View, investing for dividends can be an appealing approach in volatile markets. In particular, for long-term growth investors, dividends have provided more than 50% of long-term total return in stock investing, while dividend-paying stocks have offered more than one-third less volatility than non-dividend-paying stocks. 

For income-oriented investors, dividends can provide attractive current income, but more significantly, they can provide the opportunity for solid income growth. This is an important point, as it appears that U.S. investors increasingly have come to rely upon dividends as a source of income. According to a 2013 research note from S&P Dow Jones Indices, in 2011, dividend income was 6.12% of per-capita personal income in the United States, versus 4.16% the previous 10 years and 3.58% 20 years earlier.1 During that period, the share of interest income shrank steadily, to 7.7% of per-capita personal income in 2011 from 14.87% in 1991. The S&P Dow Jones note also pointed out that the value of total dividend income (in 2000 dollars) increased, to $792.9 billion in 2011 from $180.3 billion in 1990—a growth rate of more than 300%. Interest income grew less than 100% during that time.

Currently, the S&P 500® Index has a dividend yield of roughly 1.9%, according to Bloomberg, while the Barclays U.S. Aggregate Bond Index yield hovers around 2.2%, based on data from Barclays. In other words, from the yields of today’s markets, the current dividend income from a broad basket of U.S. stocks wouldn’t be much lower than the income received from a broad basket of high-quality U.S. bonds.

Nevertheless, most investors would likely shy away from the comparable level of income received from stock dividends in lieu of bond income because of the inherent volatility in stocks. Perhaps they wouldn’t if they considered that stocks have the potential to provide much more attractive growth of income relative to bonds. Chart 1 compares the annual income that an investor would have received from the Barclays Aggregate and the S&P 500 during the 1976–2013 period, assuming that the investor withdrew the yield of the Barclays Aggregate and the dividends of the S&P 500 each year. The starting point is an initial investment of $10,000 in each index. 

 

Chart 1. Dividends Historically Provided More Income Than Bonds on the Same Invested Amount
Annual dividend income (S&P 500) and interest income (Barclays Aggregate) on $10,000 invested in the respective indices, 1976–2013 

Source: Morningstar, Factset, and Barclays.
Past performance is no guarantee of future results.
The historical data are for illustrative purposes only to illustrate the historical performance S&P 500 stocks according to their dividend policy and do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results.
The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.
Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. There is no guarantee that investors will experience the type of performance reflected above. Due to market volatility, the market may not perform in a similar manner in the future.
Dividends are not guaranteed and may be increased, decreased or suspended altogether at the discretion of the issuing company.

 

In the first year, you’ll see that the investor would have received more income from the bond investment, much like today’s yield differential. However, bond income is highly sensitive to swings in interest rates, and as yields fell over time, so did the income stream. In contrast, as the underlying value of the stock portfolio grew (due to price return only—remember that dividends are being withdrawn each year) the annual income from stock dividends not only eclipses that of bonds but also grows to much higher annual levels. In fact, by the end of the period illustrated in the chart, the stock portfolio had grown to more than $200,000 and was producing more than $4,000 income per year, nearly 10 times the initial income stream. The bond portfolio had barely changed in value, definitely not keeping up with inflation, and the income stream had declined markedly to the low yield levels we see today. One other observation: Even if yields had maintained their higher levels of the 1970s, the income from dividends in a stock portfolio would still have been much higher.

Perhaps most interesting is that the dividend yield on the S&P 500 hasn’t increased either; it’s actually decreased from nearly 5% in the 1970s to the near 2.0% we see now. (It has hovered near the 2% mark for the better part of the last two decades.) In Chart 2, we illustrate this point. The bottom dark green line shows the annual yield on the S&P 500. 

 

Chart 2. Even as Nominal Dividend Yield Stayed Flat, S&P 500 Dividend Income Continued to Rise
Annual yield on initial $10,000 invested in the S&P 500 Index in 1976 versus nominal dividend yield on index, 1976-2013 

Source: Strategas Research Partners LLC, Morningstar, and Factset.
Past performance is no guarantee of future results.
The historical data are for illustrative purposes only to illustrate the historical performance S&P 500 stocks according to their dividend policy and do not represent the performance of any Lord Abbett mutual fund or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. There is no guarantee that investors will experience the type of performance reflected above. Due to market volatility, the market may not perform in a similar manner in the future.
Dividends are not guaranteed and may be increased, decreased or suspended altogether at the discretion of the issuing company.

 

But focusing only on the nominal yield level doesn’t tell the complete story. What becomes more important than dividend yield is a concept known as yield on cost. In other words, what would be the dividend income today as a percentage of the initial $10,000 amount invested at the start? For the stock portfolio, by the end of our illustration, it reaches upward of 30%. Why is that? As the value of the underlying stock portfolio rose over time, the investor earned more income from the dividend yield on an increasingly larger dollar amount. For investors searching for income in a low-yield world, this simple but powerful concept could be a very viable solution.

Now that we’ve outlined the potential benefits of dividends, is there a particular approach to building a dividend-focused portfolio that could add value for investors? We’ll examine that topic and more in upcoming editions of Market View.

 

Aye M. Soe, “Dividend Investing and a Look Inside the S&P Dow Jones Dividend Indices,” S&P Dow Jones Indices, March 2013.

 

 

MARKET VIEW PDFs


  Market View
  U.S. Market Monitor

INCOME FROM DIVIDENDS
The Lord Abbett Series Fund Calibrated Dividend Growth Fund invests in stocks of large U.S. companies that have a history of increasing dividends.

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