DIVIDEND YIELDS ARE A vital part of the long-term return generated by the stock market. In fact, since 1926 (the first year for which we have comprehensive data on the S&P 500 Index), dividends have contributed an average annual return of 4.2 percent, accounting for fully 42 percent of the stock market’s annual return of 10.0 percent for the period.

An astonishing revelation.

Compounded over that long span, dividends made a contribution to the market’s appreciation that is almost beyond belief. Excluding dividend income, an initial investment of $10,000 in the S&P 500 on January 1, 1926, would have grown to more than $1.7 million as 2017 began. But with dividends reinvested, that investment would have grown to some $59.1 million! This astonishing gap of $57.4 million between (1) market price appreciation alone and (2) total return when dividends are reinvested simply reflects (once again) “the magic of cost-free compounding” (Exhibit 6.1).

The stability of the annual dividends per share of the S&P 500 is truly remarkable (Exhibit 6.2). Over the 90-year span beginning in 1926, there were only three significant drops: (1) a 55 percent decline during the first years of the Great Depression (1929–1933); (2) a 36 percent decline in the Depression’s aftermath in 1938; and (3) a 21 percent decline during the global financial crisis of 2008–2009. This most recent decline occurred largely because banks were forced to eliminate their dividends. Dividends per share on the 500 Index fell from $28.39 in 2008 to $22.41 in 2009, but reached a new high of $45.70 in 2016, 60 percent above the earlier peak in 2008.

Mutual fund managers give dividend income a low priority.

Given the obvious power of compounding dividends over the long term and the relative stability of corporate dividend payouts, actively managed mutual funds must give dividend income a high priority. Right?

Wrong! Because mutual fund management contracts consistently call for advisory fees that are based on a fund’s net assets—not on its dividend income. When stock market dividend yields are low (as in recent years), fund expenses consume a huge share of the total dividend income earned by funds.

The result: a staggering proportion of equity fund dividend income is consumed by expenses. “Staggering” is no overstatement. In actively managed growth funds, expenses actually consume 100 percent(!) of fund income. In actively managed value funds, expenses consume 58 percent of dividend income.

The contrast between actively managed funds and comparable index funds is stark. The comparable value index fund expenses consumed 2 percent of fund income in 2016; the expenses on a low-cost growth index fund consumed just 4 percent (Exhibit 6.3).

Actively managed equity funds confiscate your dividend income.

Despite the powerful impact of dividends on long-term returns, you, like nearly all investors, are likely unaware of this astonishing confiscation of dividend income. How could you know? While it may be possible to calculate these data from a fund’s financial statements, those statements are hardly beacons of full, clear, and forthright disclosure.

So why not consider a low-cost index fund, which has no active portfolio manager; has an annual expense ratio as low as 0.04 percent; which delivers your fair share of the fund’s dividend income; and does virtually no trading of stocks through those Helpers mentioned at the outset? Why not, indeed? Chapter 13 explores this idea further.