Oh, I know the next big market crash of the century is certain to occur at some point, but even if I knew exactly what day that market crash is destined to start (which I don’t), I still wouldn’t change my investment behavior one little bit. Like an obtuse and stubborn deer staring into the oncoming headlights, my plan is to hold my stocks and reinvest the dividends without using higher brain functions of any kind.
In fact, did you know that I am actually hoping for the stock market to crash, and for prices to stay low for the rest of my life? Were that to happen, my portfolio would be a mere fraction of where it stands today. Oh ho ho, how sweet would that be?
Would you like for me to tell you precisely how sweet it will be when my portfolio crashes through the floor along with everyone else’s? Let’s look at how sweet it can get, using actual historical data. Now just imagine that it is September of 1929, and I own shares of an S&P 500 fund. The only investment activity I ever undertake is to collect dividends and uncritically reinvest them straight back into the S&P 500 without so much as glancing up from my coffee and donuts. One day, a magical genie (who I know to be perfectly trustworthy and benevolent towards savvy investors like me) gives me a very timely heads up. The market is about to crash by 90% and will not see another high until September of 1954, at which point my investment career will come to an abrupt close. My choice is to either ignore the genie and keep on keeping on, indulging my monotonous habit of reinvesting dividends back into more shares of my S&P 500 fund at whatever price is then available, or I could be smart and play it safe. I could sell everything that very day, put the money into bonds and continually reinvest the interest each month at whatever interest rate then prevails for US Treasuries.
By the time September of 1954 rolls around and the S&P 500 finally regains its former 1929 high, would I have been better off sticking with stocks, or having shifted into US Treasuries just before all hell broke loose in the equity markets?
To find out the answer to this question, I pulled Professor Robert Shiller’s stock market data that he makes available for free to the public on his homepage. Shiller Stock Data. I added some new columns – one where I start out with 1,000 shares of a hypothetical S&P 500 fund worth $31,429 as of September 1929, and another where I have invested $31,429 worth of principal into bonds that pay a floating interest rate equal to the then prevailing rate for a 10-year US Treasury. In the first case, I collect the dividends from my S&P 500 fund each month (at the rate shown in Professor Shiller’s historical data) and reinvest them back into the market at whatever price the S&P 500 is then trading at. In the second case, I harness the power of compounding by reinvesting my interest payments into more and more bonds.
Do your instincts tell you that I’d be better off with bonds for the period between 1929 and 1954? You’ve probably seen this chart of the S&P 500 from 1929 to 1954. Most investors take for granted that this is the single worst period ever to have been a stock investor.
In fact, by September of 1954, it turns out that my bond portfolio will have grown to $60,757 – almost twice my initial investment. But my stock portfolio, by contrast, will have grown to $129,958… over four times my initial investment! That’s a rate of return of 5.85% per year, painting a very different sort of picture than the stock price chart you see above.
Take a look at the difference between a dividend-reinvested S&P 500 portfolio compared to a floating interest rate reinvested bond fund using Shiller’s historical data for 1929 to 1954 – the red lines show the bond portfolio, and the jagged blue lines show the dividend reinvested balance on a hypothetical S&P 500 fund. For most of the years, bonds outperformed, but once those reinvested dividends started to work their magic, there was no looking back.
It gets even more interesting when you put this result into a modern perspective. Using the dividend reinvestment calculator at Dividend Channel Calculator, I found that the 5.85% annual return from 1929 to 1954 is actually slightly better than the rate of return you’d have earned if you’d bought an S&P 500 fund in July of 2000, reinvested the dividends and held onto the shares until today.
I have to be honest with you: this result initially came as a huge shock to me. If you had asked me earlier today “would you rather own stocks from 1929 to 1954 or from 2000 to 2019?” I’d have laughed in your face, and blithely given you the incorrect answer with a haughty sniff, radiating beams of condensed-100%-pure confidence. Surprisingly (to me, at least), what is widely recognized as the longest and most severe bear market in the history of the United States was, in fact, a glorious boon for the type of investors who have a penchant for repetitiously reinvesting dividends at whatever stock prices they can get at the time. Turns out they’d have outperformed even the most diligent compound returns investor from the modern era.
This result becomes a bit less surprising when you stop and think about it. Investors who reinvest dividends THRIVE on low stock prices because lower prices translate directly into more shares at more affordable prices, which then lead to more dividends, and so on, ad nauseam. Bull markets, however, restrict the power of compounding since every reinvested dividend buys that many fewer shares of corporate earnings power. Even the heady capital gains accompanying those higher highs and howling TV personalities on CNBC can’t compete with the tedious drumbeat of compounding dividend income.
So, how sweet is a 90% stock market plunge followed by a grueling 25 year bear market? The answer is “roughly an extra .19% a year, on average.” The good news people is that day will come eventually. If we’re lucky.
And so, without any further ado, here is a link to the modified Shiller spreadsheet. If anyone catches any mistakes in my formulas, or wants to point out anything obvious that I might have overlooked, please leave a comment. Modified Shiller Spreadsheet.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This is not investment advice and I am not an investment advisor. I cannot independently confirm the accuracy of any of the data from DividendChannel.com or from Professor Robert Shiller’s homepage, which was used for the financial analysis in this article.