Quality shares (and managed share funds) are expected to generate higher returns than most other asset classes over the long term. The return from quality shares comprises a potential growing income stream as well as capital growth.
How do shares generate a potential growing income and capital growth?
Shares (and managed share funds) have the potential to generate a growing dividend stream for investors. As illustrated by Chart 1*, the annual income generated by a $100,000 investment in a selected portfolio of shares since 1983 (with income not re-invested) started off low, but then gradually built up. In fact, last year’s income was $49,078, or 49% on the initial $100,000 investment.
The reason for the increasing dividends from shares can be said to be a product of a company not distributing all of its profits to shareholders. Instead, companies regarded as having a high quality business retain some of their profit each year and use it to invest in the business – to help it grow.
If this is done well, it means they’ll have more profit the next year – from which they can afford to pay shareholders a higher dividend than they did the previous year. Plus they will again retain some profit for re-investment. So the next year their profits will hopefully be higher again, allowing the company to distribute an even higher dividend while still retaining more profit for re-investment. And even more the next year. And so on.
Of course, the more the value of the company grows as a result of the re-investment of the retained profits, the more the market tends to recognise this and people may be prepared to pay more to buy their shares. Hence the capital growth.
Compare the income stream from shares to a well known income producing investment – the term deposit. As shown in Chart 1, a $100,000 investment in term deposits since 1983 did well while interest rates were at historical highs, but then income dropped away to just $3,200 or 3.2% at the start of 2016. Compare that to the $49,078 income from shares last year.
In fact, since 1983, the $100,000 investment in term deposits generated a total income of just $236,250 compared to $1,180,404 from shares. Add to that the $1,287,713 in capital growth from shares – as at 1 January 2016 – and you have a total return of $2,468,117 from shares, compared to $236,250 from term deposits, as shown in Table 1.
What is the risk of investing in shares?
All shares and managed share funds experience volatility. Their values all go up and down – on a daily basis. That’s because shares are easily traded on the stock exchange with the price at which they are bought and sold dependent on market sentiment, which can be affected by the latest news and short term conditions. You can buy and sell most of the top ASX-listed shares almost whenever you want. The trade-off for that liquidity and convenience is a bumpy share price.
However, with quality shares (and managed share funds) generally speaking, over time prices have tended to go up more than they go down, as shown in Chart 2 which indicates historic annual returns from a selected portfolio of shares.
As a result, over time shares have the potential to generate solid capital growth. In fact, history has shown that the longer an investor holds shares or managed funds the probability of a negative return is reduced, as you can see in Chart 3.
These graphs are for illustrative purposes only. Past performance is not an indicator of future performance.
Disclaimer: This article is not legal advice and should not be relied on as such. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. You should obtain financial advice relevant to your circumstances before making investment decisions. Where a particular financial product is mentioned you should consider the Product Disclosure Statement before making any decisions in relation to the product. Whilst every care has been taken in the preparation of this information, Australian Unity Personal Financial Services Ltd does not guarantee the accuracy or completeness of the information. Australian Unity Personal Financial Services Ltd does not guarantee any particular outcome or future performance. Australian Unity Personal Financial Services Ltd is a registered tax (financial) adviser. Any views expressed are those of the author and do not represent the views of Australian Unity Personal Financial Services Ltd. If you intend to rely on any tax advice in this document you should seek advice from a tax professional. Australian Unity Personal Financial Services Ltd ABN 26 098 725 145, AFSL & Australian Credit Licence No. 234459, 114 Albert Road, South Melbourne, VIC 3205. This document produced in April 2016. © Copyright 2016