Personal Finance

Give the dividend its due

Aarati Krishnan | Updated on January 22, 2018

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Dividends have made a big difference to long-term returns from equities

It’s dividend season at India Inc and if you own a large portfolio of shares, you are probably getting scores of intimations on dividend credits to your bank account. And if you are like most investors, you are probably ignoring them.

Well, that’s where we are making a mistake. Though Indian investors are often fixated with capital appreciation, dividends do make a significant difference to our long-term returns from equities.

Re-investing dividends

But isn’t the dividend yield on Indian shares quite low? The Nifty dividend yield is only 1.4 per cent, after all. Yes, but stocks are a long-term investment and over a 5-10-year period, dividends (if properly reinvested) can bump up the portfolio returns quite a bit.

To gauge how much of a difference dividends can make, you only need to compare the Total Return indices disseminated by the stock exchanges to the widely used price indices. The NSE, for instance, disseminates the Total Return index on its bellwether Nifty index. This index captures the effective returns on the base index if the dividends paid by the constituent companies were re-invested in the index.

For the last one year, if the plain vanilla Nifty (capturing only the price) is down by 3.41 per cent, the Nifty Total Return index is down 2.35 per cent. If that 1 percentage point does not seem much, it adds up to quite a lot over a 5-10-year time-frame. (All returns computed as of November 4, 2015).

Over a five-year period, the Nifty has made absolute gains of 30.8 per cent. But the Nifty Total Return index is 8 percentage points ahead, at 38.8 per cent. Over a 10-year period, the gap gets wider.

An investment of ₹1 lakh in the Nifty in November 2005 would be worth ₹3.28 lakh now, if you consider only price appreciation; but it would be worth ₹3.76 lakh — 15 per cent more if you had systematically tracked and re-invested the dividends.

But this is the number for the index stocks. If you own a portfolio that has a number of FMCG or tech companies, cash-rich public sector firms, public sector banks or other liberal dividend payers of India Inc, chances are that dividends amount to an even higher segment of returns in your case.

Separate account

This cumulative impact of dividends on portfolio returns argues for keeping track of all your dividends in a systematic manner and making sure that you re-invest them quickly.

Owning a separate bank account into which you direct all your ECS payments would be a good idea, to segregate and invest your dividend income promptly.

If re-investing your dividends back into the same stocks (which is what Total Return calculations assume) is difficult, you could plough them into a good diversified equity fund or, if you are risk-averse, a bank fixed deposit, so that the compounding effect can get to work.

Vanishing outperformance

But the Total Return concept is not just useful to remind you to be disciplined about dividends. It is useful when you evaluate mutual fund performance too.

Today, a majority of index funds and exchange traded funds (ETFs) in India end up ‘outperforming’ their chosen indices, because they are benchmarked against the plain vanilla price indices.

Therefore, while the index fund does receive dividends from its portfolio of companies and re-invests them, its returns look superior when they are compared to just a price index. If Total Return indices are used, the relative performance no longer looks as good.

Take the Nifty-based index funds and ETFs for the last one year, for example. If one uses the Nifty index (down by 3.41 per cent) to compare returns, 12 of the 18 funds have outpaced it. But if you consider the Total Return index (down by 2.35 per cent), 15 of the 18 funds fail to match it.

Dividend themes

While the difference that dividends make shows up quite clearly in the case of index funds, the dividends received should make a significant difference to the portfolio returns of diversified equity funds too. The dividend contributions would be particularly high for funds which are overweight on themes, such as oil and energy, high dividend yield stocks, PSUs, PSU banks, consumer stocks and Shariah strategies.

These are pockets of companies in the Indian market that pay out high dividends.

If you own funds heavily tilted towards them, you should use the Total Return indices to evaluate their real performance.

Therefore, the next time you take stock of the performance of your personal portfolio against benchmarks, do it against the Total Return indices. That will ensure that you don’t ignore the difference that dividends can make to your long-term wealth.

Published on November 07, 2015

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