I’ve often wondered how my returns would compare vs an index fund. Its not straightforward to judge this given ongoing investments of capital over time, which make calculating total returns a little difficult. I had some time over the long weekend and the assistance of Morningstar’s portfolio tool, which led to some interesting results.
I’ve never been overly concerned with the total return performance of my dividend portfolio versus an index fund because I’ve primarily been focussed on the dividend stream that my portfolio has been generating to fund financial independence.
Intuitively though, I feel that my dividend fund is superior to an index fund for a bunch of reasons. Also, I know that a rising dividend stream creates long term wealth by the virtuous cycle of dividend increases, and investors chasing that higher yield.
Still, I’ve always wanted to assess how the Integrator $50k fund would have tracked vs an index fund. Frankly, if the performance vs the index fund was lousy over a long period of time, I may be leaving money on the table, and be better off putting my money in a index fund and just cashing out my holdings periodically to realize an income stream.
My expectations before I actually sat down to run the numbers was that I’d be reasonably close to the return of an index fund, but that was more a guess than anything else.
The actual calculation of performance returns over the years isn’t straightforward because you need to adjust for contributions and withdrawals which can make calculating portfolio returns a little painful . If you don’t do this and you make regular inflows, it artificially bumps up your actual performance returns.
I used Morningstar’s Portfolio Manager as the basis upon which to track my performance. Its a great tool and its free for those who register with Morningstar.
I highly suggest entering your data early on when you start up your portfolio, and then get into a habit of maintaining this regularly if you want to benchmark yourself vs an index, Its pretty painful to go back retrospectively and enter all your transactions.
As most of my holdings over the years were in my Australian stocks, I’ve focussed primarily on my Australian shares for tracking. The results go back as far as Morningstar would let me, which is a 10 year view. I’ve also looked at the performance of my US holdings over the last 12 months given I’ve been adding substantial investment into this portfolio recently.
A couple of things to note:
- The Integrator $50k fund return shown below is stock price appreciation, not total return (which would include dividends). I could have added yearly dividend income to this, but it’s a little complicated and would have taken way too much time on a sunny long weekend than what it was worth!
- To ensure I compare Apples with Apples, I’ve benchmarked vs the ASX All Ordinaries Index Price Return Index which does not include dividends. This index is price appreciation of the leading companies on the Australian Stock Exchange, reweighted for changes in market capitalization
- Morningstar allows you to capture a “personal return” which actually tracks inflows and outflows and when you invested. This is the measure that I’m showing below.
So how do I compare?
My annual portfolio growth over the last 10 years for my Australian portfolio and the ASX Index is shown below.
I did a similar analysis of the return on my US dividend stocks over the last 12 months, which suggested a total return of 33% vs the S&P 500 return of 15%. This was largely driven by a small cap, non dividend payer that I still have in my holdings called Medidata Solutions, which is up more than 133% since purchase, as well as strong contributions from Visa, Mastercard, Western Union and Chicago Mercantile Exchange.
At some point, I intend to go back and extend my US return analysis through till 2007-2008 to see the impacts when I have more time.
1) Happily, I outperformed the index over an extended period of time. If you look at period returns, I beat the index for 8 out of the 10 years for which I tracked my performance. There were 2 years that I underperformed the index though, and 2008 in particular is where my returns were absolutely decimated.
However, when all is said and done, I outperformed the index over the 10 year period, generating an annual capital appreciation of 8.51% vs the index of 4.63%.
A $10k investment in the Integrator $50k fund in 2003 would be valued at close to $23k at the end of 2012, vs a return of just under $16k in a equivalent Australian index fund.
This return is excluding dividends
2) My total return here is actually understated given dividends have not been included in measuring performance. When you factor in an effective yield of about 4% annually on the portfolio, I’ve probably been returning close to 13% annually in total return over the last decade.
Given an index contains a grabbag of companies, many with less progressive dividend policies, I expect the inclusion of dividends in a total return calculation will see the Integrator $50k portfolio further outperform the index. It just goes to show you that investing in dividend paying companies can produce very handy long term returns and generate meaningful capital growth.
3) Surprisingly, my returns compared to the index are not even that close. There has typically been a variance of at least 5%+ every year generally closer to 10%. This probably means I must have a lot more alpha in my portfolio than I thought. The reason that I’m surprised is I do hold a number of the larger cap stocks in the index, though I think my philosophy of buying when there is panic has helped a lot, juicing up returns much greater than the index.
4) An investor in Australian stocks would have done reasonably well over the last 10 years. It clearly wasn’t a lost decade for growth in Australian markets, largely because economic conditions have been so good over this patch of time, and because the Australian economy has largely avoided any economic correction for the better part of 20 years. With dividend yields higher than US markets, annual total returns for the index would have been close to 8-9% annually.
5) The effect of leverage has been both a boon and a curse in my portfolio. During the 2004-2007 period when returns were rising, I was able to ride the wave of increasing asset returns and really boost my equity through the use of leverage. Portfolio growth was great up till 2007. But just look at what happened in 2008. Forced selling at precisely the wrong times really worsened returns in this year and really exacerbated 2008 performance, where my portfolio lost almost 50% of it’s value….
6) I’ve only really started investing in small cap dividend payers in the last couple of years, but they’ve already had a significant impact on my total return in this period. The major reason my 2012 return was significantly above the index were due to some small cap dividend payers which returned greater than 50% in 2012. Small cap investing can be fairly volatile, but the right companies with strong business models can generate outsize returns.
- A focus on dividend growth stocks can lead to index outperformance, even though that isn’t necessarily a focus of the strategy.
- Leverage can blow returns in tough times. As you can see above, it takes a long while to recover from a 50% fall in your capital base.
- The right small cap dividend payers can be a powerful contributor to dividend income and stock price appreciation.