Income-hungry investors should not overlook the importance of dividends, which have accounted for nearly half of the S&P 500’s total return since 1900.
The pivotal role of dividends is an often-overlooked part of investing, but it should be top of mind for a generation of baby boomers looking for income-generating investments. Since 1900, dividends have accounted for approximately 50% of the total return for the S&P 500 Index.
Past performance does not guarantee future results. Source: Jack W. Wilson and Charles P. Jones, “An Analysis of the S&P 500 Index and Cowles’s Extensions: Price Indexes and Stock Returns, 1870–1999”, Journal of Business, 2002, vol. 75 no 3. Data after 1990 is from Bloomberg, Confluence, and FactSet. Calculated by Thornburg Investment Management. Returns are annualized.Three Schools of Thought
There have traditionally been a few schools of thought of how to best to fund expenses in retirement. A total return approach involves targeting an asset allocation and total return for the portfolio and a portion of the retirement assets is sold periodically to cover expenses. While this approach attempts to provide the growth that retirees need to outpace the effects of inflation, assets may need to be sold at sub-optimal intervals.
The second approach focuses on high-yielding income investments that are expected generate sufficient current income to cover expenses. This approach can leave a retiree with limited opportunities to grow spending power and can be prone to the erosive impacts of inflation.
However, there is a third approach that is a hybrid of the total return and high-income approaches. Investing in stocks of companies that provide both high and growing dividend income can benefit a retirement portfolio undergoing the duress of withdrawals. This investment strategy has the potential to generate both a growing income stream and capital appreciation coveted by retirees.
Focusing on Yields
When reviewing income-generating alternatives, retirees often focus on current yield (current income divided by price). This works well for fixed income investments, which are contracts that pay a certain level of income to the bond holder each year and then return the principal amount at maturity. However, for equity investments, where both the income and stock price may appreciate, looking solely at current yield can disguise the growth in the dollar amount of the income generated.
Investors who focus on buying the highest-yielding investments have always been drawn to bonds. However, since 1990, bond yields have dramatically declined. Below is a comparison of bond yields versus equity yields over calendar years. At first glance, it’s obvious that current yields on bonds are higher, but this higher yield comes with little to no potential for growth.
Bond Yields vs. Equity Dividend Yields
Past performance does not guarantee future results. Source: Bloomberg. Dividends were not reinvested. Data through December 31, 2024. Dividend and interest income are not guaranteed.To show the difference between the growth of income provided from bonds versus a dividend-paying equity investment, we calculated the amount of income generated annually on a hypothetical $1 million investment made in 1990. While the income from the bond investment steadily declined from 1990 to 2020, the amount of dividend income derived from the dividend-focused equity allocation grew steadily. Although beginning at a relatively modest level compared to the bond investment, the dollar amount of dividend income surpassed the bond income by 2000 (10 years) and bested it by 970% ($427,984 vs. $39,976) by the end of 2024. For this example, the bond interest and stock dividends were being used to support expenses and not being reinvested.
Bond Income Versus Dividend Income
Annual Income from a Hypothetical $1 Million Investment Made in January 1990
Past performance does not guarantee future results.Source: Bloomberg. Dividend and interest income are not guaranteed. Assumes an initial hypothetical $1 million investment. Bonds are represented by the Bloomberg Barclays U.S. Aggregate Bond Index and stocks are represented by the S&P Dividend Aristocrats Index, an index of S&P 500 constituents that have increased their dividend payouts for 25 consecutive years or more.
Total Return and Dividend Reinvestment
Investors have historically purchased equities, or stocks, which represent proportional ownership in a company, hoping their shares will appreciate in price as the company becomes more profitable. But stocks may deliver other benefits as well. As companies prosper and mature, they often share some of their profits with shareholders in the form of cash dividends, although this is not guaranteed. Like bond interest payments, cash dividends represent a current form of income. Unlike bond interest payments, which remain fixed for the life of the bond, cash dividends paid to equity shareholders may grow over time. Below we show the benefit of the S&P 500 Index with dividends reinvested as compared to a basic S&P 500 return.
Source: S&P Dow Jones Indices from May 1971 to February 2025. The S&P 500 was launched on 4 March 1957, so data prior to that is back-tested hypothetical data. Past performance is no guarantee of future results. The chart is provided for illustrative purposes and reflects hypothetical historical performance.Dividend Income in Retirement
To illustrate how a dividend-grower strategy can be used to fund a retiree’s expenses, the chart below assumes a hypothetical $1 million investment in the S&P 500 Dividend Aristocrats Index beginning in January 1990. To calculate the retiree’s spending, we assume that 5% or $50,000 will be needed to cover pre-tax expenses in the first year of retirement and then increase that amount annually by a 3% cost-of-living adjustment to cover inflation. For the early years in retirement, when dividends don’t fully support the spending, the retiree will redeem a portion of the investment to cover the shortfall. For the later years, dividend income, beyond what is needed for spending, was reinvested in the portfolio.
Dividends for Retirement Income from S&P 500 Dividend Aristocrats Index
Past performance does not guarantee future results Source: Calculated by Thornburg Investment ManagementInvestors cannot invest directly in an index.
This hypothetical illustration assumes the investor chose a Lifestyle Spending Policy with an initial spending rate of 5%. The spending rate was increased by 3% annually.
In this hypothetical, dividends weren’t sufficient in the early years to generate the desired $50,000 income, although some principal covered the shortfall. However, the portfolio generated sufficient dividend income to cover 100% of the retiree’s spending after seven years. Once 100% coverage was achieved, it never fell below that level and was able to generate excess dividends that were reinvested in the portfolio. The initial $1 million investment in 1990 produced $6.8 million in dividends of which $3.0 million was spent and $3.8 million reinvested. The portfolio value, as of December 31, 2024, was $23.8 million.
For most retirees, developing a growing dividend income stream should be an attractive alternative to the common total return or high-income approaches. Having a retirement portfolio that generates sufficient income to cover expenses while also producing continued growth should be a goal for every retiree.
The Benefit of Global Diversification
Before implementing a dividend growth strategy, investors can make an adjustment that could enhance both portfolio selection and diversification. Investors can improve outcomes by looking for companies around the globe that offer both a high and growing dividend, rather than limiting the investment universe to just domestic stocks. The United States isn’t the only region where investors can find attractive dividend-paying stocks. As shown below, dividend yields are higher outside of the U.S. and are generally higher across more sectors, allowing for the construction of a more diversified income portfolio.
Dividend Yield by Country
Source: Bloomberg, as of 31 December 2024.Diversification does not guarantee or protect against a loss.
Another benefit of having a global view is the opportunity to improve a portfolio’s diversification by industry sector. Global diversification may benefit investors seeking attractive dividend opportunities. In the U.S., attractive dividends are typically concentrated in the real estate and utilities sectors. But, as this following chart demonstrates, additional research is needed because yields across sectors vary from region to region.
Global Dividend Yield by Sector (%)
| Sector | USA | Europe Ex-U.K. |
U.K. | Nordic Countries | Australia | China | EM Latin America | Japan | |
|---|---|---|---|---|---|---|---|---|---|
| Energy | 3.3% | 6.2% | 4.8% | 6.8% | 5.3% | 7.4% | 11.9% | 4.0% | |
| Utilities | 3.2% | 5.2% | 4.6% | 4.5% | 6.4% | 5.1% | 5.9% | 3.2% | |
| Real Estate | 3.6% | 4.7% | 5.4% | 1.0% | 3.2% | 3.3% | 8.2% | 3.1% | |
| Consumer Staples | 2.6% | 3.2% | 4.9% | 4.1% | 4.0% | 3.3% | 4.3% | 2.6% | |
| Financials | 1.9% | 5.3% | 5.0% | 5.5% | 4.4% | 5.7% | 7.1% | 4.0% | |
| Materials | 2.1% | 3.1% | 5.3% | 4.1% | 4.1% | 3.9% | 7.3% | 3.4% | |
| Industrials | 1.6% | 2.6% | 2.0% | 2.7% | 3.8% | 4.0% | 3.3% | 2.6% | |
| Health Care | 1.9% | 2.9% | 2.9% | 3.2% | 2.2% | 1.3% | 2.8% | 2.8% | |
| Telecommunications | 1.0% | 3.3% | 4.7% | 1.6% | 4.0% | 1.2% | 5.8% | 2.4% | |
| Source: MSCI Country and Regional Indices sourced via Bloomberg. Highlighting illustrates all yields that are greater than or equal to 3.0% EM = Emerging Markets | |||||||||
Key Takeaway
As the baby-boomer generation progresses on the road of retirement, a dividend-grower strategy may be a prudent addition to their equity portfolios as part of a core investment strategy. Not only can growing dividends help contribute to the retiree’s distributions, but the portfolio value may also have the ability to outpace inflation through price appreciation.
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