Sunday, April 22, 2018

Do Not Underestimate The Power of Dividends

One of the underlying principles of The Bedokian Portfolio is in dividends (with bond coupons and bank interests included), which is why the tag line for it is “passive income through dividend and index investing”.  Dividends serve as the compounding effect in the early part of portfolio building, and then later as passive income when one is ready to retire.

On a shorter term, dividends can magnify your gains and mitigate your losses. Here’s how.

You May Be Earning More Than You Think

Take for instance the SPDR STI ETF, one of the ETFs that track the Straits Times Index, which is considered to be the proxy for the local equity market. If you had bought 10,000 shares of the ETF on 4 Jan 2010 (the first business day of 2010) at $2.971, and the price of it on 20 Apr 2018 was at $3.572, you would have made ($3.57 x 10,000) – ($2.97 x 10,000) = $6,000.

However, if you factor in the dividend component for that same period, and assuming that your number of shares remains at 10,000 throughout, your dividend amount would be $7,5203. Therefore if you realise your gains today, you would have made about 45% of your initial investment made eight years ago.

Let us use the ABF Singapore Bond Fund, which is deemed as the de facto local bond ETF used by many investors, as another example. Using the same dates and number of shares as per the SPDR STI ETF example above, you would have only made ($1.12 x 10,000) – ($1.10 x 10,000) = $200, a paltry sum4. But, if you include its distributions, you would gain $1,6485, still substantially more than the capital gain. 

With dividends factored in, you may be earning more than you think.

You May Be Losing Less Than You Think

Returns = Capital gains/loss + income.

This is the formula that we know for returns. The income component would be the dividends. So, in the event of a capital loss, we could still get positive returns if the income component is larger than the loss. Also, in the event of negative returns, the positive income part could help mitigate the overall loss.

Now brings the part of the terms realised and unrealised gains/losses. Realised means that the gains/losses are materialised and the investment concerned has been transacted for the monetary value. Unrealised means that the gain/loss exist on paper value and this value could change from a gain to a loss or vice versa depending on the price of the investment.

Back to the returns equation, as long as the investment is not sold off, capital gain/loss is unrealised, but the income component is always realised, since the dividends/coupons/interest earned is already in your pocket. 

So, in the event of overall negative returns, you may be losing less than you think.

1, 2 – Yahoo Finance. SPDR STI ETF. 22 Apr 2018). Closing price of the day is used.

3 – State Street Global Advisors SPDR. SPDR Straits Times Index ETF (ES3). Dividend Information. 22 Apr 2018). Dividend payouts between 2 Feb 2010 and 20 Feb 2018 are used.

4 – Yahoo Finance. ABF Singapore Bond Index Fund. 22 Apr 2018). Closing price of the day is used.

5 – ABF Spore Bond Index Fund ETF (A35). 22 Apr 2018). Dividend payouts between 15 Oct 2010 and 15 Jan 2018 are used.

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