The key to healthy stock returns

The UK stockmarket had a lacklustre year in 2014, barely posting a positive return. But over the long term, equities have been the top performer among the main asset classes, as Barclays points out in the Equity Gilt Study.

Since the end of 1899, British stocks have returned an inflation-adjusted annual average of 5%, compared to 1.3% for gilts and 0.8% from cash. Over 50 years, equities also eclipsed UK government bonds, having risen by an annual real average of 5.7%, compared to gilts’ 2.9%.

But these gains are mostly not due to price rises. The key is continuously reinvesting the income that shares produce, which allows returns to snowball. A £100 sum invested at the end of 1899 would now be worth just £184 – after adjusting for inflation – without the impact of reinvested dividends.

In other words, the stake wouldn’t even have doubled. With reinvestment, the value of the original stake soars to £28,261, over 600 times more. Apply the same calculation to gilts, and the ravages of inflation become clear. You would be left with £457 today if you had put your income back into your holdings; if you hadn’t, you would be left with just 75p.

An initial £100 invested in stocks in 1945 jumps to £5,118 with reinvested income; without it, it would only have grown to £261. Starting with £100 in 1990 would mean a return of £379 today if you had consistently reinvested. The lesson is clear: seek out dividends, and plough them back into your portfolio.

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