Previously, I discussed some of the virtues of investing in dividend stocks. There seems to be a lot of misleading information out there when it comes to dividend stock investing. Truth be told, investing in dividend stocks and growth stocks each have their pluses and minuses. We can talk all day about the virtues of each method. But when it comes down to it, performance is what matters. How does a portfolio of dividend stocks compare against growth stocks?
Our first contender will be the Vanguard Growth Index Investor fund (VIGRX). This is a 4-star fund per Morningstar that invests in large and mid-cap growth stocks. VIGRX will be pitted against a portfolio of 25 companies from the Dividend Aristocrats list. As a reminder, the Dividend Aristocrats consist of companies that are included in the S&P 500 and have increased dividends each year for the past 25 years. We’ll compare the two over two different time periods.
First, we’ll look at the 20-year period from January 1997 through December 2016. This period encompasses the tail end of the dotcom boom and the subsequent burst. It also includes the build up to the financial crisis and the bull market that followed and continues today.
We will also look at the 8-year period from January 2009 through December 2016 to see how each method performs in just a bull market.
Let’s take a look at our dividend portfolio that will be running against the S&P 500. Note that I’m not advocated the following portfolio. This is simply a random selection of 25 of the 51 Dividend Aristocrat stocks.
We’ll first take a look at the 20-year period between January 1997 and December 2016. Using this calculator, I calculated a total return for this portfolio as well as the Vanguard Growth Index. Ready for the results? Take a look below.
January 1997 – December 2016
That’s a huge difference! Not the result I was expecting. Why is this? Keep in mind this period encompassed 2 significant downturns in the market. The financial crisis and the dotcom bubble were the second and third largest market crashes in modern history. In a bear market, dividends are your friend when it comes to minimizing losses. Those dividends help you buy more shares when prices are low, and thus result in higher returns when prices rebound. As the saying goes with the stock market, be greedy when others are fearful.
Here’s a detailed summary of the returns from the dividend portfolio in case you’re interested.
Now let’s take a look at how the two methods compare during a bull run. For the 8-year period between January 2009 and December 2016, see the results below.
January 2007 – December 2016
This time, we see the growth stocks outperform the dividend stocks. So what did we learn from this? Blue chip dividend stocks outperform during down markets. However, growth stocks have the edge when it comes to bull markets.
What about the S&P 500? Indexing with the S&P 500 has become a popular strategy. The S&P encompasses all of the Dividend Aristocrats and includes growth stocks as well. So what happens in this comparison? Not much difference. The S&P does perform better than the Vanguard Growth Index over the 20-year period from 1997-2016. This makes sense as the S&P 500 contains numerous dividend stocks. However, the gap between the two is still significant. The results from the 8-year period from 2009-2016 are much the same as we already saw.
A well-diversified dividend stock portfolio comprised of blue chip stocks will outperform growth stocks during a bear market. Other studies back up my data above. The graph below compares all 51 Dividend Aristocrat stocks against the S&P 500 over the past 10 years. This time period includes both the bear market from the 2008 financial crisis and the subsequent recovery.
As you can see above, the Dividend Aristocrats do not fall as far as the S&P 500 during the bear market. Additionally, the compounding effect of dividends can be seen over time. Those dividends continue to buy up cheap shares when reinvested in a bear market. Thus, you’re able to pick up more cheap shares which increase returns over time.
I’ll have to admit I was not expecting these results. And it’s definitely causing me to rethink part of my investing strategy. While index funds offer simplicity, dividend stocks hold up better in down markets which help increase returns over the long run. One thing I haven’t yet mentioned is taxes. If you’re investing in dividend stocks in a taxable account, you’ll have to pay taxes on dividends. While dividends receive preferential tax rates, this still cuts down on the amount you can reinvest. I haven’t found a way to include this into my analysis, but given teh large gap seen above, I assume the results of the 20-year dividend portfolio would still outpace its competition even after considering taxes.
On the positive side, building a dividend portfolio over time can lead to an increased yield as companies increase their annual dividend. In the 20-year example above, the yield on your initial investment increases to 17.43% by December 2016. This assumes you’re investing a lump sum at the beginning. Most people will be dollar cost averaging over time. So while you’re actual yield won’t increase to quite that amount, it will still increase well above the initial yield you purchase at and will continue to increase over time.
Readers, what are your thoughts on dividend stocks vs. growth stocks after you’ve seen the numbers? Do you value the simplicity of index funds over less volatility in bear markets from dividend stocks? Are you willing to put in some extra work to manage a dividend stock portfolio for higher returns over the long-run?