So I have this chart that I show all the time when I’m writing about personal finance. It’s the finance equivalent of that picture of your kids you keep in your wallet – the one with creases where you’ve folded it a hundred times.
It’s a chart of the S&P 500 since 1970:
I use it to show people that historically stock ownership has been a good bet. It’s a bumpy ride for sure but, like a turbulent flight, it still leaves you safely up in the atmosphere. Since an S&P 500 index fund owns pieces of the 500 largest U.S. companies, just buying that one fund and holding it would have given you this performance, doubling your money several times over.
Of course, this chart is not entirely good news. There are fairly long periods that would, peak to peak, have netted you zero dollars. From this chart alone, we can see that the stock market was pretty much flat from 2000 to 2012, despite some fun rollercoaster moves in between (this is the green line on the chart above). So while I use this chart to champion passive index ownership as a way to build wealth, plenty do the opposite. Market pessimists trot it out to show why the stock market is not a safe bet, even over the long term. Some fund managers may superimpose their performance numbers over carefully selected portions of this chart to show how easily they can beat the market (note that no underperforming fund has ever created a chart to show how badly it lost out to a benchmark).
Lastly, this chart commits the most common, egregious of investing crimes: it cannot promise you future returns. Sadly, like all charts, it can only look backward.
Even though it feels like they’re insulting my child, I understand these criticisms. But there’s good news. You know this chart I’m so fond of showing you? It’s wrong. Wrong, wrong, wrong. In fact, almost every stock chart you’ve ever been shown is wrong in a very specific way.
It’s wrong because it doesn’t account for reinvested dividends, and dividends are a significant part of the stock market’s return.
Dividends are when a company takes a small piece of itself, lops it off, and distributes it to shareholders in the form of cold, hard cash. Most people know this. But the same thing works with large indexes. Because some of the companies in the S&P 500 distribute dividends, the index itself also provides investors with a dividend. It changes, but right now it’s hovering around 2% per year.
Most investing platforms allow you to choose whether to keep these dividends as cash or reinvest them. When you choose to reinvest them, the result is downright magical.
What would my S&P 500 chart look like if it incorporated reinvested dividends?
This DQYDJ calculator can at least give us the values, if not the chart.
So the total return jumps from roughly 2,000% to a whopping 8,000%. To put it simpler, choosing to reinvest dividends gives you results that are four times better than the stated return of the S&P 500 since 1970.
What about that rough patch I told you about, the one from 2000 – 2012? Let’s apply the same dividend reinvestment plan to that
It turns out that during that period, if you reinvested your dividends you’d have gotten a 13% return, or 1% annualized. Is this great? Unfortunately not. But it’s not flat, and much better than the -8.7% the chart shows you.
Why is this? Well instead of spending your dividend cash, you’re using it to buy more shares, which themselves can grow. If investing is like farming, with productive companies taking the place of a field, then dividend reinvestment is putting aside some of your crop and using the seeds to grow more vegetables on a larger plot of land.
And since companies often cut dividends slower than the market falls during bad years, your reinvested dividends buy more stocks when they’re on sale.
This chart is more accurate to the average investor’s experience, and hopefully it can get a few more people onto the long-term investment bandwagon. I’ll probably print it out and put it in my wallet.
Disclaimer: The views expressed are for informational purposes only and are not intended to serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities by FutureAdvisor. All expressions of opinion are subject to change without notice in reaction to shifting market, economic, or political conditions. The investment strategies mentioned are not personalized to your financial circumstances or investment objectives, and differences in account size, the timing of transactions and market conditions prevailing at the time of investment may lead to different results. Clients may lose money. Past performance is not indicative of future results. Investments in securities involve the risk of loss. Any tax strategies discussed should not be interpreted as tax advice and do not represent in any manner that the tax consequences detailed will be obtained. Clients should consult with their personal tax advisors regarding the tax consequences of investing.