How the FTSE 100 returned 94% without moving

On New Year’s Eve 1999, the FTSE 100 closed at a then-record high of 6930. Few could have envisaged then that, 19 years on,
the index would be lower. It stood at 6845 as at 14 December 2018. A negative return for investors over that long a period can be concerning, but it doesn’t tell the whole story of index returns.

While price-wise the FTSE 100 has fallen since 31 December 1999, if you include dividends the index has actually returned 93.5% over the same period (or 3.54% a year), according to Windergate Capital's calculations. Dividends are a form of income paid out by companies to investors.

Dividend payments make up an important part of an investment’s total return, which includes capital growth.

Dividends can be taken as a cash payment or reinvested to buy more shares. If you opt for the latter, it enables you to benefit from the effects of compounding or what Einstein called the “eighth wonder of the world”.

Compounding enables you to earn returns on returns and can help your money grow faster.

The dividend reinvestment effect

We have crunched the numbers. As the chart below shows, if you invested £1,000 into the FTSE 100 on 31 December 1999 and left it alone, it would be worth £993 without reinvesting dividends. That’s not adjusting for the effects of inflation or charges. It also does not include the value of taking dividends as a cash payment.

However, the picture changes dramatically if you had invested in the FTSE 100 and opted to revinvest the dividends its listed companies pay.

In this scenario, if you had invested £1,000 in the FTSE 100 on New Year’s Eve 1999, your investment would now be worth £1,935. That’s an annual return of 3.54%, not adjusted for inflation or charges, compared with -0.04% if you had invested in the index alone.

Ideally, stock prices should rise too, so your capital grows along with your income. But as the data shows, even when the actual price of the index has gone nowhere, you can still earn a return on your investment if you reinvest company dividends.

The orange bars in the chart below show the theoretical investment return had you reinvested your dividends. The blue bars show the return without dividends reinvested.

As the data shows, reinvesting the dividends companies pay can make a significant difference to the value of your investment. Of course, there’s no guarantee that your investment will rise in value over time.

Dividend payouts are an increasingly important part of an investor’s portfolio, especially with bond yields near historic lows. The UK stock market currently pays out an average of around 4% in dividends, compared with around 1.3% for UK government bonds.

It is one of the reasons we always advocate a long-run approach to investing. It’s also why dividends are often said to account for the majority of returns from the stock market over the long-run.

Dividend reinvestment is a simple technique. Over time, those seemingly small amounts reinvested can grow into much bigger sums if you use them to buy even more shares that pay dividends in turn.

Investors need to do their research and make sure the company they are investing in can afford to pay their dividends on a sustainable basis. Your original capital is also at risk, so it pays to be picky.

A poor run for the FTSE 100 explained

Like many stock markets around the world the FTSE 100 has suffered in the second-half of 2018, erasing most of the gains it made over the last two years.

Concerns over global economic growth, the potentially damaging effects of a trade war between the US and China and the uncertainty over the outcome of Brexit has hit investors’ confidence.

The FTSE 100’s travails also have some similarities to the events of 1999. In recent years, technology stocks such as Apple and Facebook in the US and Sage in the UK have helped propel stock markets to record highs.

These so-called “growth” stocks have been chased higher by investors who were willing to pay more and more for their potential earnings growth. The problem is that when it looks like the economy is about to slow, these growth stocks start looking expensive, as their projected earnings will become harder to achieve.

The sell-off in technology stocks is just part of the reason why the FTSE 100 and global stock markets have begun to retreat in 2018.

It was a similar story nearly 20 years ago at the height of the "dotcom" boom. Internet companies, or anything with ".com" in its name, were the most wanted stocks in town. When the bubble burst, the stock market began to fall, more than halving in value from top to bottom, as the chart below shows.

It is of course unwise to draw firm conclusions from stock market history and past performance is not a guide to future returns.