Dividends versus Capital Appreciation

Which is more important to retirees? Dividends or capital appreciation? Or does it make a difference?

Answer: Dividends. They are much more reliable.

Price-Only Returns

Here are the equations that relate real, annualized, price-only returns of the S&P500 index and the percentage earnings yield 100E10/P. I used 1923-1975 sequences.

Year 1 Price-Only Returns, x=100E10/P

y=3.2513x-18.949 plus and minus 40%.
R-squared=0.1259.

Year 10 Price-Only Returns, x=100E10/P

y=1.2199x-7.3831 plus and minus 8%.
R-squared=0.2784.

Year 20 Price-Only Returns, x=100E10/P

y=0.9244x-4.8381 plus and minus 4%.
R-squared=0.4177.

Year 30 Price-Only Returns, x=100E10/P

y=0.3127x+0.2767 plus and minus 2%.
R-squared=0.2593.

Dividend Yield

This equation relates the S&P500 dividend yield with the percentage earnings yield 100E10/P. I used years 1923-1975.

Dividend Yield versus Earnings Yield, x=100E10/P

y=0.3597x+2.0226 plus 2.0% and minus 1.5%.
R-squared=0.5044.

Predictability

Dividends have the strongest relationship to the percentage earnings yield 100E10/P. We can see this by comparing R-squared values.

Year 20 Price-Only Returns have almost as strong a relationship to the percentage earnings yield. Year 10 and Year 30 Price-Only Returns have much weaker relationships. The single-year relationship is the weakest.

Safe Withdrawal Rates

I have shown in numerous articles that there is a strong relationship between the percentage earnings yield 100E10/P and the Safe Withdrawal Rate. Here, 100E10/P = 100/[P/E10] using Professor Robert Shiller’s P/E10. P is the current (real) price (or index level) of the S&P500. E10 is the average of the previous ten years of (real) earnings.

I have shown that there is almost as strong a relationship between the percentage earnings yield 100E10/P and future stock returns.

I have shown that Safe Withdrawal Rates are most tightly related to what happens within the first 10 to 15 years of a retirement. By that time, the portfolio has either grown enough to be secure or it is already in danger.

Conclusions

Dividends shine in two ways. First, they change the statistical distribution in Gummy’s Safe Withdrawal Rate equation. They provide a floor. Dividend amounts seldom decrease.

Why Dividends Are Better

Second, dividends are tied strongly to the percentage earnings yield, which accurately predicts the Safe Withdrawal Rate.

In contrast, the Price-Only returns are not as tightly related to the percentage earnings yield. The relationship is strongest at Year 20. It is weaker at Year 10. The most important years for retirees occur in between. They are Years 10 through 15.

Dividends are more reliable.

Have fun.

John Walter Russell
September 7, 2006