This year has been better for global dividends than it has been for some time, after many companies reduced or even cut theirs when Covid-19 hit in 2020.

Dividends are payments of income by a company to its shareholders. When investors own a share, they own a part of that company, so when that company pays a dividend, it is effectively paying out a part of its profits. Dividends, alongside capital gains from any increase in the company’s share price, form part of the total return¹ that investors may (or may not) get from investing in shares.

In the second quarter of 2024, dividend payouts were the strongest on record², suggesting they have been returning to normal after companies held them back to preserve cash during the pandemic.

Technology companies including Alphabet, Meta and Salesforce also announced their first-ever dividend payouts this year. Tech companies have not typically been associated with dividends because they often reinvest cash in the business rather than pay it out to investors, so many see these payouts as a sign that the sector is maturing.    

The return of dividends is good news for investors because they can enhance the total return of a portfolio over the long term (typically five years or more).

1. The power of reinvesting dividends

When paid out as income, dividends can provide a regular stream of spending money to investors.

When you invest in shares through a fund, you can choose to have the income paid out to you by selecting an ‘income’ share class.

Alternatively, you can choose to reinvest any dividends with the aim of growing your investment over time by selecting an ‘accumulation’ share class³. The income is reinvested by the fund in more company shares, which in turn generate their own dividends. Through the power of compounding (where you earn a return on your return as well as your original investment), reinvested dividends can meaningfully enhance your total return.

The chart below shows how reinvesting dividends can significantly accelerate the growth of your investments. The dark green area shows the return from the rise in global share prices since 1995. When combined with the return from reinvested dividends (the light green shaded area), the total return (the gold line) has grown significantly and, by the end of August, sat at around 980% - essentially double the return had dividends not been reinvested. This compounding effect can significantly increase the value of your portfolio, making dividends a powerful tool to boost your wealth.

The power of compounding when reinvesting dividends can significantly boost the value or your investments

Past performance is not a reliable indicator of future returns. Notes: Data from 29 September 1995 to 30 August 2024. Global shares market represented by the FTSE All-World Index. Calculations based on price return and gross total return in local currency for the longest history available.

Source: FactSet, Vanguard

2. Don’t forget bonds

While income may come from shares in the form of dividends, bonds also pay income in the form of interest. This interest is often more dependable than the income from shares and is why bonds are also known as ‘fixed income’.

Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest to investors and return the capital at the end of the term.

In the same way that investors who own shares through a fund can choose to have the dividends reinvested rather than taken out as income, investors in bond funds can leave the interest from bonds in their investment to compound.

Bonds also play an important role in acting as a buffer against the ups and downs of shares. Shares have typically given a higher return than bonds over time⁴, but are riskier (in that they can experience sharper swings in prices). Bonds have typically been more stable but have also offer lower potential returns. Having a mix of both in your investments can help to balance risk and reward, but remember that the value of investments can fall as well as rise.

Of course, the exact blend of investments in shares and bonds in your portfolio may change over time, depending on your goals and your attitude to risk. For example, someone approaching retirement may want to start reducing the level of risk in their portfolio and would do this by decreasing their allocation to investments in shares and increasing that towards investments in bonds.

3. Understanding risk

Some investors, particularly retirees, may focus on higher income-paying investments as the foundation for what they have available to spend in retirement. This was challenging in the years prior to the pandemic when yields from most investments were at historically low levels.

Yields can be a useful way for investors to compare the income from different types of investment. The yield shows the income from an investment, such as dividends from shares or interest from bonds, expressed as a percentage of the current price or value of the investment⁵. Funds also have yields, which show all the income from the fund as a percentage of its price, but there are different ways to measure them.

It is important to be aware of the risks associated with certain higher yielding investments because a higher yield could, in some cases, indicate a higher level of risk. Higher-yield bonds, for example, typically have to pay higher interest than other bonds because they are considered to be at a higher risk of defaulting on the interest payments⁶. This means that the bonds, as well as funds that invest in high-yield bonds, tend to behave more like shares, in that they can experience bigger swings in prices.

Similarly, with shares that pay higher yields, there is no guarantee that they will continue to do so. A high yield can also indicate that a company is out of favour because its share price has dropped (therefore pushing up its yield).

While it may seem appealing to chase shares or bonds with higher yields, or funds that invest in them, this could, in some cases, lead you to take higher risks.

Investors should instead think about their total return and, as long as they are getting the return they need to cover their income needs, it doesn’t matter whether that comes from income or growth.

A balanced view

While dividends are an important part of investing, investors can look beyond them to the total return of their portfolio. Focusing solely on income might lead to missing out on growth opportunities in shares that do not pay dividends but have potential for significant price growth.

Equally, getting too caught up in high yields can unwittingly lead you to take on a higher level of risk and could end up being costly should things not go as planned.

¹ Total return is the actual rate of return of an investment over a given period and includes both the capital gains from the increase in share price and any income payments.

² Source: FactSet, Vanguard. Data as of 28 June 2024 and based on FTSE All-World Index constituents.

³ See more information on income and accumulation share classes.

⁴ Source: Vanguard ‘Principles for investing success’, 2024.

⁵ If an investment has a price of £100 and pays an income of £5, it will have a yield of 5%.

⁶ Agencies called credit ratings agencies assess the companies (or organisations) that are issuing the bonds (known as issuers) based on their ability to repay interest and capital. Issuers that are considered to have a greater risk of defaulting are said to be ‘below investment grade’ or ‘high-yield’.