The long-term, quiet glory of dividends

February 09, 2018

In 2001 when I was putzing around the Berkshire Hathaway annual meeting in Omaha, Nebraska, I noticed Warren Buffett was selling (selling, not giving away - it's Buffett after all), an official T-shirt with his logo. The logo was a fist grabbing cash, and the artistic level was so low I assumed Buffett did it himself.

Even for an event dubbed the "Woodstock of Capitalism," it seemed crass. Buffett apparently agreed, and a few years later it disappeared completely, so much so that I had trouble finding it for this newsletter. But thanks to the Wayback Machine on the Internet, I was able to unearth an archived image of the shirt:

But inside that logo is a good lesson. If you are going to invest well, cash matters. As an owner you need to be paid. Stocks and index funds generally pay their owners through quarterly dividends, as we learned last month. Today I want to peel that dividend onion back a little more.

The importance of receiving maximum dividends cannot be overstated. John Bogle, the founder of Vanguard, gave a speech to a financial regulatory body in 2007, demonstrating that 95% (yes, you read that right: 95%) of the compound long-term return of the S&P 500 from 1926 to 2007 was due to dividend income. $10,000 invested in 1926 without dividends was worth $1,225,321 in 2007, but with dividends reinvested it was worth a stunning $34,094,516.

How could that be - that result seems, at a cursory glance, to be impossible. It's due mathematically to the surplus return of the dividend payments each year. If you added that extra return regularly, and compounded it, you achieved a long-term numerical explosion. It's the surplus in the annual percentage number that creates the seemingly magical effect.

Bogle went on to say, in his 2007 speech:

"These stunning figures would seem to demand that mutual funds highlight the importance of dividend income. But in this era of “total return,” income is virtually ignored. Why? Because dividend income plays a remarkably small role in equity fund returns. Today, in fact, the average domestic stock fund is offering a dividend yield of just 0.4 percent. Where did all the income go? It was slashed by fund expenses. The expense ratio of domestic stock funds averages 1.4 percent, reducing the funds’ gross dividend yield of 1.8 percent to 0.4 percent. Unsurprisingly, then, it appears that the average stock fund earns the stock market’s present dividend yield of 1.8 percent and then consumes fully 80 percent of that yield in fees and expenses."

And with that consumption of the dividends by mutual fund managers and investment companies, occurring quietly in a place that is hard to see, goes many Americans' retirement, drifting away quietly like chimney smoke on a cold Vermont morning.

Keep in mind these are the dividend amounts that the funds are receiving. It is a separate question whether the corporations themselves should be paying back dividends or using their cash flow to buy back shares. That topic we'll explain in a future newsletter, when you need something exciting to jazz up your weekend.

As a student of dividends, even I was amazed by Bogle's remarks. But I've come to believe it is one of the greatest observations in finance ever recorded. Charlie Munger, Buffett's partner, once took a break from hawking T-shirts and commented that "there are answers worth billions of dollars in a $30 history book." This insight, in my opinion, is one of them.

Dan Cunningham