Do the Indexes Reflect Dividends?

Recently, I wrote:

. . . it’s worth noting that, by one measure, anyway, “the market” is not at 9,300, it’s at more like 14,000. Which from a low of 1,700 12 years ago is a healthy octuple, nearly a 19% annual rate of return — plus dividends — or about double, if not a little more, than the “normal” return.

To which Thorsten responds:

“Plus dividends?? I’m not sure about the Dow, but at least the S&P 500 index already contains the dividend payments of the stocks in it. Otherwise the Vanguard Index fund and SPY etc. would do about 1% better than the index itself (dividend yield minus fees), because they do receive dividends.”

Well, no. The S&P 500 index doesn’t contain dividend payments. The comparisons made by the Vanguard Index fund, SPY, etc., are with a specially computed figure that combine the price appreciation of the S&P 500 and the dividend returns. (Both the Vanguard Index fund and SPY themselves pay dividends every year — namely, passing through the dividends of the underlying stocks.)

So when you see rules of thumb about the stock market historically returning 9% or so a year, that was not appreciation of 9% a year but, typically, 5% or 6% in price gains plus 3% or 4% in dividends.

Of course, you don’t see the 9% number much any more. Now you often see 10% or even 12% as what you can expect of stocks — the historical norm. But that’s because the last 17 years have been so phenomenal, raising the historical norm.

There are those who believe in “regression to the mean,” which in Biblical terms simply means that seven fallow years follow seven fat. So all these above-average years of late have been swell. Truly. But though they raise the historical average, they do not necessarily raise the gains we can expect of the future.

And dividends, I am so old-fashioned as to believe, might even one day come back into fashion, especially if we ever stop double-taxing them. They are, after all, cash. And cash is useful when you need to, say, pay for things.