Should You Pare Back Your Exposure to Stocks?

By Pam Martens and Russ Martens: May 6, 2020 ~

John Bogle Founder of the Vanguard Group

John Bogle, Founder of the Vanguard Group

Yesterday, Disney, a component of the Dow Jones Industrial Average and a former darling of stock analysts, suspended its dividend. Unlike most companies that pay a quarterly dividend, Disney pays a semi-annual dividend. The company is suspending just the dividend it would have made in the first half of this year without comment as of now on what will happen to the dividend in the second half of the year. Disney’s prior CEO, Bob Iger, was paid a combined compensation of $193.3 million over the prior four years. He stepped down as CEO in February.

Dividend cuts and suspensions of dividends are now at their highest level since the financial crash of 2008-2009 with just over 200 companies slashing or eliminating their dividends thus far this year. Here’s a sampling of some of the biggest names:

Disney: Suspended its dividend for first half of 2020.

Ford: Suspended its dividend.

General Motors: Suspended its dividend.

Goodyear Tire and Rubber: Suspended its dividend.

Royal Dutch Shell: Cut its dividend by 66 percent.

Schlumberger: Cut its dividend by 75 percent.

There is no question that more big names will follow with dividend cuts or suspensions.

In addition to hurting retirees’ sources of income in the short term, the cuts to dividends are going to deliver long-term pain to the total returns investors are expecting from the stock market. Total return represents the combination of growth in the share price combined with the reinvestment of cash dividends.

Just how significant dividends are to the long-term total return delivered by stocks was succinctly explained by John Bogle in his 2010 book: “Don’t Count on It!: Reflections on Investment Illusions, Capitalism, “Mutual” Funds, Indexing, Entrepreneurship, Idealism, and Heroes.” Bogle was the founder of the low-cost mutual fund company, Vanguard Group. He is credited with creating the first index mutual fund. Bogle passed away on January 16, 2019 at age 89. Bogle wrote as follows in the book:

“Theory tells us, and experience confirms, that dividend yields play a crucial role in shaping stock market returns. In fact, the dividend yield on stocks has accounted for almost one-half of their total long-term return…

“When we take inflation into account, the importance of dividend income is magnified even further. During the past century, the average rate of inflation was 3.3 percent per year reducing the nominal 5 percent earnings growth rate to a real growth rate of just 1.7 percent. Thus, the inflation-adjusted return on stocks was not 9.6 percent, but 6.3 percent. In real terms, then, dividend income has accounted for almost 75 percent of the annual investment return on stocks.”

Bogle is also remembered here at Wall Street On Parade for delivering an eye-opening warning to investors relying on their high cost 401(k) plans to allow them to retire with dignity and adequate income. On April 23, 2013, Bogle appeared on the PBS program Frontline. Bogle exposed a fact that Wall Street has attempted to hide for decades. That is, if you work for 50 years and receive the typical long-term return of 7 percent on your 401(k) plan and your fees are 2 percent, almost two-thirds of your account will go to Wall Street.

Bogle explained the math to Frontline producer Martin Smith, as follows:

Bogle: “What happens in the fund business is the magic of compound returns is overwhelmed by the tyranny of compounding costs. It’s a mathematical fact. There’s no getting around it. The fact that we don’t look at it— too bad for us.”

Smith: “What I have a hard time understanding is that 2 percent fee that I might pay to an actively managed mutual fund is going to really have a great impact on my future retirement savings.”

Bogle: “Well, you have to rely on somebody to get out a compound interest table and look at the impact over an investment lifetime. Do you really want to invest in a system where you put up 100 percent of the capital, you the mutual fund shareholder, you take 100 percent of the risk and you get 30 percent of the return?”

Here’s how you can check the math yourself. Access a compounding calculator on line. Input an account with a $100,000 balance and compound it at 7 percent for 50 years. That gives you a balance of $3,278,041.36. Now change the calculation to a 5 percent return (reduced by the 2 percent annual fee) for the same $100,000 over the same 50 years. That delivers a return of $1,211,938.32. That’s a difference of $2,066,103.04 – the same 63 percent reduction in value that Bogle predicted.

One critical thing that Americans should take away from this experience with the pandemic is that, in one way or another, through inaction or inattention or apathy, we have all contributed to our country becoming a wealth transfer scheme for the one percent.

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