The media has a complex relationship with capital markets. It knows capitalism is important, both for business and for individual savers, but finds the whole process far too confusing and so ends up continually referring to a few things it thinks it understands. That is why there is a constant focus on salaries and profits with little reference to risk, capital employed, investment, the competitive environment or anything that is not large and obvious. Things like dividends expressed in pence per share just seem trivial compared to a million pound bonus.
Financial intermediaries use the media as an easy reference point for explaining the world of personal finance to their clients and the investing public at large. In particular most people refer to the capital value of stock market indices such as the FTSE 100. Looking at that over the last thirteen years they feel justified in saying it has been an asset class that has delivered poor returns.
However, that statement totally misses the point and simply demonstrates they have grasped the wrong end of the stick. On a total return basis the FTSE 100 is nearly 50% higher than it was at the turn of the millenium. The FT All Share is up over 60% on the same basis. The market has not been flat or down, it has delivered good returns. And that includes the corporate disasters experienced by BP and the banking sector. Some might claim that selecting the market peak in 1999 is bound to favour dividends at the expense of capital growth.
So let’s look at a different starting date; say 16th March 2003 which was the trough after the tech bubble. Since then the simple FTSE 100 index has grown an impressive 192.75%. Not bad. But not as dramatic as the 276.5% recorded by the FTSE 100 Total Return. Even over this fairly short period of strong capital growth dividends provided 30% of the total return.
This discrepency is simply explained by the almost unseen, but unrelenting force of dividends that have been paid out, reinvested and grown again by the alchemy of compound interest. In other words, even in this relatively short space of time dividends have provided one third of the total return of the UK stock market. Whisper it quietly, but the secret of equity investing is not capital growth, but dividends.
Many investors might well respond that it is all very well recounting the progress of an index but, because you can’t actually buy the index, they invested in individual stocks or in collective investments and their experience has not matched the benchmark. Buying individual stocks is a time consuming business simply dealing with corporate actions. Most people have got better things to do with their time than being an unpaid settlements clerk.
Buying a fund is an easier option. There is though a problem. That 49% return from the market peak in 1999 to date sounds good, but annualised it is only 3.8% a year. Knock off 5%, or even 3%, as an initial charge and you can see that one whole year of returns went to the service providers. Then deduct the annual management charge of maybe 1%, or as much as 2.5% in a fund of funds, and you can see that that the investor is not left with much of that total return, maybe only 1% net of that 3.8% gross return. And that is assuming the fund manager stuck fairly close to the index, secured the returns of the asset class and didn’t blow up on some wild hunch that went wrong.
Of course someone will say you can find a manager that will beat the index. However, no one has run a fund over the last thirteen years that has beaten the index by investing solely within that index over that period.
So it suits the industry to keep refering to the capital values of the index because there is a possibility that one of their products might beat that measure; or at least not lag it too much. They know they won’t beat the total return index. So if it suits the industry then it suits the media because it is fed by the great PR machines that drives modern fund management. One reason why brand is more important than cost in fund selction for most investors.
If there was one thing the FSA could do with its last breaths before morphing into the FCA should be to insist that all references in the media to stock market indices be accompanied by the level of the index on a total return basis as well. Once investors understand what they could have got they might exercise some more discrimination. Looking at dividends will prove to be more rewarding than chasing capital growth. The right measuring stick must be Total Return not capital only.
Past performance is not a guide to future returns. The value of investments and the income from them may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. For risks relating to specific products, please refer to the relevant documentation for that product.