What is the effect of dividend reinvestment on drawdowns and recoveries?

[Free-quent Flyer]

Anyone who knows me knows I have an unfortunate tendency towards literalism. When people make offhand remarks or spout cliches, I butt in and ask, "is that really true?"

On Twitter the other day I saw @Matt reply to a banker or advisor saying that some market or industry had been "flat for five years." Matt quipped "yeah but dividends" or something pithy like that.

And on the one hand, he's obviously right. A flat share price doesn't mean your investment hasn't appreciated — it's potentially appreciated by the amount of any reinvested dividends.

On the other hand, I couldn't help but wonder, what is the actual effect of reinvested dividends on an investment? To find out, you'd have to know what price you bought in at, how many dividends were distributed, and at what price they were reinvested.

Fortunately all this information is readily accessible! So, being literal-minded, I checked.

To run this little experiment, I took the least favorable possible conditions: an investor who bought 1 share in a Vanguard mutual fund on the day that fund peaked in 2007. They reinvested all the dividends paid out by that mutual fund throughout the financial crisis and until it reached its previous peak. In other words, throughout the entire period during which the mutual fund could be said to be "flat." What was the effect of those reinvested dividends on our investor's account value?

Here are the funds and values I used:

• VFIAX, 10/9/07, $144.23 per share through 3/14/13, $144.68 per share.
• VEMAX, 10/31/07, $48.46 per share through 1/26/17, $31.51 per share (the fund still hasn't recovered to its 2007 peak)
• VTMGX, 10/31/07, $16.79 per share through 1/26/17, $12.24 per share (as above, the fund has still not reached it 2007 peak).

So, what was the effect of reinvesting dividends on the account value of each mutual fund?

• VFIAX. The maximum drawdown wasn't affected much since it happened so early in the recession. On 3/9/2009 the share price bottomed out at $62.66, a 56.56% drawdown, while the account value was a touch higher, with a drawdown of $55.21%. The account returned to roughly its original value in March, 2012, a full year before the share price fully recovered. And in March, 2013, when the share price fully recovered the account value was 12.82% above its October, 2007 value. In other words, a "flat" 5.5 years returned 12.82%.
• VEMAX. Again the maximum drawdown wasn't affected much, 67.02% versus 64.70% in March, 2009. With reinvested dividends, today the account value is 18.21% lower than it was in October, 2007, while the share price is still 34.98% lower. Reinvesting dividends roughly halves the drag of the lower share price on the account's value.
• VTGMX. The maximum share price drawdown in March 2009 was 62.72%, while the account value was reduced by 60.61%. Today, the share price is still 27.10% below its October, 2007, peak, while the account value is just 6.03% below its value in October, 2007.

The core logic behind reinvesting dividends is not to increase your account value. It's to increase your share count. Today, an investor in VEMAX and VTGMX would own 26% and 29% more shares than they purchased at the market's peak. If and when the market returns to those peaks, the share price will be "flat" but the investment will have quietly compounded in the background while the share price was tanking.

In other words, "yeah but dividends."

Attached Excel spreadsheet showing my work, I don't have any fancy data subscriptions.

 

[volker]

That's is also the benefit of some stocks that are known for their dividends. Actually they are also often bundled into specific high dividend funds. One factor left out here is fees which can drop the rate slightly.

As an example Coca Cola paid out $0.35 in dividends in the last four quarters. With todays stock value that is ~3.4%. The rate can change over time and some companies stop paying out dividends in the past. Actually, a unrelated side note, you can also buy stocks with -- depending on the amount -- reduced fees directly from the companies. Coca Cola offers this as one of many examples.

Just a quick google search came up with this NASDAQ page that lists a current dividend yield of up to 21.90% (http://www.nasdaq.com/dividend-stocks/)