1

From my understanding:

*To keep it simple, we will keep the asset as index S&P500, not including asset allocation.

Compound interest (or compounding interest) is interest calculated on the initial principal, which also includes all of the accumulated interest of previous periods of a deposit or loan.

*I am aware that stocks pay dividends and not interest, but aren`t the dividends calculated to a % yield of the underlying stock which is converted to a dividend yield which is the same as interest earned?

Here is the part that I don`t understand in our current market condition:

The current S&P500 is paying less than 2% in the dividend yield

My understanding is that the compounding factor is 2% (Not including the growth factors of ~8% for S&P500)

So are we mostly relying on the growth of the market and consistent periodical investing instead of relying on the compound interest effect?

Because in our current time the historic dividend yield is very low?

So the only thing we can rely on is to the rate (time period) of the compound because the rate of the compound is low?

SP500 Mean & Median: https://www.multpl.com/s-p-500-dividend-yield

Mean: 4.32%

Median: 4.27%

Min: 1.11% (Aug 2000)

Max: 13.84% (Jun 1932)

2

So are we mostly relying on the growth of the market and consistent periodical investing instead of relying on the compound interest effect?

Yes.

Dividend Irrelevance Theories suggest that the decision of whether to Pay Dividend depends which on which return is higher:

  1. A company pays dividend to shareholder, who then invests the dividend in the broad market index or industry peers;
  2. A company keeps dividend, then expands the business (such as investing in new store outlets, branches, R&D.

Therefore, the "compounding" takes effect within the company, rather than at the individual shareholder's level, when Dividends are not paid.

There also other factors affecting such decision, such as Corporate Tax Rate vs Individual Tax Rate, Cost of Raising Additional Capital after Paying Dividend, etc.

To an individual investor, Total Return (Price + Dividend) is what matters for the most of the time. So if an investor who targets 4% dividend to cover his monthly expense but feels that S&P 500's 2% dividend is too little, the investor can sell an additional 2% worth of shares each year to "self-create" dividend. Similarly, if an investor has a decent job and does not need dividend, the investor can opt to "auto-reinvest" the dividend.

Furthermore, the Stock Price drops on average exactly equal to the Dividend per Share on Ex-Dividend Date.

2

I am aware that stocks pay dividends and not interest, but aren`t the dividends calculated to a % yield of the underlying stock which is converted to a dividend yield which is the same as interest earned?

No. A company pays a dividend based on their accumulated profits. They don't look at the current price of the stock to determine the amount of the dividend. They take a portion of their profits and return that to the investors. They like to keep the dividend per share either consistent or slightly increasing to keep investors happy.

After the dividend is announced the investors then calculate the yield from the stock price.

If over time the company is very profitable, and doesn't have a lot of opportunities to invest their profits for growth, the investors put pressure on the board to increase the dividend to increase the yield. But in general they don't start with the stock price when determining the dividend.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.