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The Power of Reinvested S&P500 Dividends

Jake - Author/Founder

Hi. I'm Jake, a frugal Canadian Engineer. I believe you can build a great life through frugal living and index investing.

A study of the S&P500 history is useful for boring index investors like me.

After all, S&P 500 index funds are extremely popular among investors. 

This is easy to see when looking at the mammoth index funds VOO from Vanguard and SPY from State Street that have over $1 trillion invested in the S&P500.

Looking back at the S&P500 dividend history can teach you other useful things:

  • How dividends affect total S&P500 returns
  • Dividend stability
  • Dividend growth rate
  • How taxes affect total returns with dividend reinvestment

Dividend Contribution to S&P500 Returns

If you crunch the numbers on S&P500 returns over the last 100 years (1922 – 2022), you will find the following:

  1. Annual S&P500 return without dividends reinvested: 6.34%
  2. Annual S&P500 returns with dividends reinvested: 10.4% 

What Are S&P500 Dividends?

The S&P500 index is a collection of 500 large profitable U.S. companies. What does the dividend of the index represent? 

It represents the weighted average of the total dividends paid out by these 500 companies. 

A dividend is a cash payment to shareholders. It is a way for a company to share its earnings with company owners (you). 

Not all companies in the S&P500 pay a dividend. Some, like Google, prefer to distribute earnings to shareholders via share buybacks instead of dividends. 

Huge companies like Apple make up a larger part of the index than small companies. This type of index is called a Capitalization Weighted Index.  

This means that most of the index dividend comes from the largest companies in the index.  

S&P500: No Dividends Reinvested vs. Dividends Reinvested

I crunched some of Robert Shiller’s S&P500 data to build this chart. It highlights the effect of reinvesting dividends. 

I like this chart. It tells the story. 

Let’s assume you invested $1,000 into the S&P500 in 1980 (42 yrs ago). In 2022 you would have:

1. $33,500 without dividends reinvested (compounded price return); or

2.  $93,000 with dividends reinvested (compounded total return).

You can thank compound growth for this effect.

Dividends are used to buy more index ETF shares. These shares yield more dividends. The cycle repeats, fuelling a positive feedback loop (exponential growth).

Over this time, the average dividend yield was 3%, and the price return was 8%. The total return was 11%. 

A total of 27% of the annual return came from dividends.

With the current low S&P500 yield, dividends don’t make as large of a contribution as they did in the past. But even a 1% difference in returns will result in a huge difference when compounded over the long term.

Price Return vs. Total Return Index

The index value with re-invested dividends is called the “Total Return Index”. Otherwise, it’s called a “Price Index”. 

The price index is proportional to the weighted market caps of the underlying companies in the S&P500 index. 

Consider the chart that shows up when you google “S&P500 Index”. The chart is the “price return” chart, which does not include reinvested dividends.

In addition, the value of an index ETF security follows the price index. It took me a while before I figured this one out. 

As of writing this, the S&P500 dividend yield is nearing its all-time low of 1.64%. You can find the real-time trailing 12-month yield here.

How to Access S&P500 Dividends

You can access the dividends of the S&P500 index by investing in an S&P 500 index fund. Such a fund will hold all 500 stocks in the S&P500 index. 

The fund then collects the dividends from the 500 stocks and distributes them to you, the fund owner. Typically, fund distributions occur every three months. 

The funds come in the form of index ETFs or index mutual funds. 

If your brokerage allows, you can even turn on a Distribution Reinvestment Program (DRIP) with most ETFs

Learn More About Index Funds

Most people don’t know this, but 93.95% of US mutual funds underperformed their benchmark index over the past 15 years ending in 2022. 

The best book to lay the foundation for index investing is The Little Book of Common Sense Investing by John Bogle. The book also provides great context to history as John Bogle founded Vanguard. He is known as the pioneer of index investing.

Finally, you can learn more about the theory and evidence behind index investing on this page. 

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S&P500 Dividend Growth and Stability

S&P500 dividends have grown at an average annual rate of 6.0% per year between 1971 and the present (based on Shiller’s Data).

I’ve graphed out the S&P500 dividends relative to S&P500 earnings, adjusted for inflation. Dividends are sturdy. 

S&P500 Dividend Stability Graph

The plot and the average dividend growth rate of 6.0% tell you two important things:

  • Dividend growth has outpaced inflation in the long term; and
  • Dividend growth is stable relative to S&P 500 earnings, and even more stable relative to the S&P500 index price.

If you like stability you’ll naturally gravitate towards dividend-yielding businesses or indices.

Although dividends don’t matter for total return, they do feel nice psychologically. 

I personally find comfort in a robust growing dividend from an index or an individual stock.

Top 8 Books To Grow Wealth

Taxes: A Drag on Dividend Compounding

Dividends are taxed, even if you reinvest them immediately. This imposes a “tax drag” that reduces the compounded effect.

The good news is that you can avoid tax drag completely by using tax-sheltered accounts (RRSP, TFSA, 401K, Roth IRA, HSA, ect). Just watch out for Foreign withholding tax drag if you invest in foreign equities.

In addition, dividends will be taxed at lower tax rates compared to employment income. To learn more about taxes, check out this guide on investment taxes for Canadians. 

This plot shows the result of a 15% tax drag on total S&P500 returns. 

S&P500 Dividends Tax Drag

What about the DRIP?

Dividends are automatically reinvested under a  distribution reinvestment program (DRIP).

Under this program, the index fund distribution is used to buy more shares of the stock or ETF, without paying commission fees. 

Dividends are still taxed when automatically reinvested under DRIP. 

To learn more about DRIP with ETFs, check out this post on DRIP with Index ETFs. 

How to Calculate Tax Drag on S&P500 Dividends

The overall tax drag represents the loss in total returns from dividend taxes. The drag depends on two factors:

  1. The dividend tax rate; and
  2. The dividend yield.

Consider an investor named Kara. Kara pays a 15% tax on dividends. She holds Vanguard’s VOO S&P500 ETF that provides a 1.4% dividend yield.

Kara will have an overall dividend tax drag of: (15%)(1.4%) = 0.21%. So, her total returns will be 0.21% lower than the Total S&P500 index returns. 

But, there are also fund fees that add additional drag. The total tax drag including fund fees can be found by adding the MER to the dividend tax drag.  

VOO has a tiny MER of 0.03%. The total tax drag will then be: (15%)(1.4%) + 0.03% = 0.24%. Kara’s returns of holding VOO will be 0.24% lower than the total S&P500 return. 

This 0.24% compounded over 30 years at a 10% return results in a portfolio value at the end of year 30 that is 6.34% lower relative to the no-fee case.

This is insignificant, especially relative to mutual fund fees of 1% to 2.5%. 

Dividends Don't Matter (Numerically)

Once I understood where stock returns come from, I realized that dividends don’t matter. 

Only the total return matters: price growth + dividends. A company will see more share price growth if it retains earnings or uses share buybacks instead of paying cash dividends.

Dividends, therefore, come at the cost of price growth. Dividends are irrelevant to the long-run total return.

But cash dividends may have psychological utility. For example, cash payments can keep people grounded in times of turmoil. It can also help people leave their investments untouched, as they spend dividend cash. 

In addition, the S&P 500 is heavily weighted with mega-cap growth tech stocks. These monsters favour share buybacks to return money to shareholders rather than dividends.

For more, you can learn more about common dividend misconceptions. 

Bottom Line

  • The price of the ETF or individual stock that you see on searches does not include reinvested dividends. Look up the total return if you want to the return with reinvested dividends.
  • Dividends are a large component of total S&P 500 index returns, with 40% of the annualized return attributed to dividends over the past 100 years.
  • Dividends are much more stable than earnings or index prices over time.
  • S&P500 dividends have grown at 6% annually over the past 50 years, beating inflation.   
  • Tax drag on the compound effect will reduce total returns, even if you use the DRIP.

Did you like this post? If so leave a comment and join the newsletter so you don’t miss out on weekly posts that help you improve financial literacy. 

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Robert Shiller

You’ve heard me reference Robert Shiller a few times as I used his data. 

He is a well-known economist who argues that human behavior has a large effect on markets during booms and busts. Sometimes, we can act irrationally in aggregate, becoming a tad exuberant at times. 

Robert Shiller also developed the famous market valuation metric – the Shiller P/E ratio, also known as the Cyclically Adjusted Price to Earnings Ratio (CAPE Ratio). It shows how expensive the stock market is relative to history. 

The metric shows that the S&P500 in 2022 has an extremely high valuation relative to history, even after the downturn. Given high valuations, one can expect lower future returns. 

Thanks for reading. I hope this helps you along your wealth-building journey. 

Jake out. 

2 thoughts on “The Power of Reinvested S&P500 Dividends”

  1. Great post, Jake! Very informative. It really is a shock to see how much of a difference reinvesting the dividends makes over time. I always reinvest all dividends in my portfolio. Thanks for sharing.

    1. Thanks, Graham. The effect of dividends compounded over time surprised me as well. The wonderful nature of compound growth.

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