In the past I wrote two posts sharing about a friend who starts dollar cost averaging 2 months before the great financial crisis.

You can read about them here:

• Oh Shit! I started DCA investing at the top of the bear market
• Dollar Cost Average into STI ETF right before GFC revisited

As a primer, the STI ETF is like a listed unit trust that mimics what stocks are held in the Straits Times Index, an index of Singapore Blue Chips, or largest companies in Singapore. If the index go up 1%, the fund must go up 1% and vice versa. You are entitled to received dividends, as the underlying blue chip business distributes dividends so the STI ETF, at the discretion of the manager, distributes an average dividend. You pay a brokerage commission to buy it and annually there is a 0.3 to 0.4% expense for the internal cost of managing it.

The two articles studies the effects of disciplined dollar cost averaging way to build wealth with a single country based index (Singapore). The second article provides an encouraging result in that the IRR turns out to be 5%.

However, one thing that bugs me is how that original investment 2 months before the GFC would have turned out if its not a dollar cost average, but a lump sum investment.

That first purchase was carried out at $33.61 or some where when the STI index is at 3300. If you study the STI Index you will realize that the price of the index is barely above 3300 for the past 7.5 years.  The highest point reached was 3500 and momentary at 3800.

7.5 years and we are still below it.

The DCA results show that if you put in your hard earned wealth fund in the STI ETF, you would end up positive. In the case of a lump sum, you would have lost money. However the dividends distribute over the past 7.5 years makes up for the disappointment.

The IRR up to now is 2.82%. That’s somewhat like an insurance savings endowment’s rate of return. There are folks that tell me this is too low of a return, to justify the kind of stomach wrenching volatility they need to go though. That is fair enough. To invest with this approach you have to understand the philosophy of what is necessary, and a large part of it includes how ETF investing works, what you need to do and behavioural finance (or how your brain will make you do stupid things).

We won’t know what the future would bring, and I find there is too much things sold based on USA based indexing that preaches you will make 7% returns per annum. This is as if all country will mirror the returns of USA.

When it comes to single country index investing, things might not be so simple after all.

Still this studies does show the ability of dividends as a form of market return that should be counted as part of your return, and an important part at that.

The story is not completed yet, there are still many years to go.

I came across a rather interesting simulation of index investing. It tries to bring readers into a discussion whether you would want the index of which your unit trust or exchange traded fund is benchmarked to, to rise or fall within the next near term time frame.

We all suffer from the psychological problem of feeling more pain seeing the market value of what we own fall drastically from $100k to $50k. You might say you are ready for it, but nothing prepares you from the actual ordeal. 8 out of 10 of those long term investors who believe they can take large 50% volatility swings will be cutting losses. Many will exit the game all together.

Conversely, it makes you feel like a god when you see a drastic tripling of the market value of your holdings, you start thinking whether the market is overvalued and you should be selling.

Jesse in Why a 66% Crash would be better than a 200% rise explains that, if you are accumulating for retirement, it makes sense to see a market crash of epic proportions in the next 1 or 2 years.

The most interesting fact is the simulation takes place when there is a plunge and the price NEVER recovers to the high price:

Surprisingly, you would end up wealthier at retirement if the plunge occurred. This is true even if we assume that the plunge lasts forever, and that you add no new money to the market as prices fall.

An index is an aggregation of some of the biggest companies in the country or region. These companies pay dividends. With population growth, economic growth, inflation, dividends will grow. Jesse assumes that the dividend yield starting was 3% and this dividend grows at 2% per year.

Why does it outperform the situation when the market goes up 200%?

• The dividends are reinvested to buy more shares. If you have something good, wouldn’t you want to buy at cheaper price. The same concept here. The plunge allows the wealth builder to buy at a much cheaper price per share
• Dividends are increasing and a plunge makes you buy MORE shares early. The wealth builder uses the dividends to purchase more shares at lower prices. 20 years later, each of these shares dividend per share have grown that he has more money to be reinvested.
• Time. The plunge situation takes some time to eventually catch up

STI ETF from 2002 to 2014

One thing i find the simulation unrealistic is that, under no circumstances does the dividend per share went down. Its not realistic because, during recession, the underlying companies that make up the index makes less money and thus the payout should  be reduce.

What Jesse is illustrating is that, over time, the growth rate of all this dividend ups and downs evens out to 2%.

In the Singapore context, the closest illustration to something near this is the period from 2008 to today, where on an average 2008 ranks amongst the high of 3500 to 3800, which has not been attained for the past 6 to 7 years.

The price trend looks vastly different from the major European or the USA markets, in that, they have yet to breach the old highs.

I have tabulated the corresponding annualized dividend yield. For 2014, the STI ETF have not declared the second half dividend, though i suspect it will be 5 cent bringing the annual amount to be 9.3 cents.

Corresponding to the dividends, I have tabulate the index ETF price at June one year ago. Why one year ago? This is because this dividend declaration should be with respect to what was earned in the last work year.

Dividends do not increase yearly

One thing we realize is that the dividend growth correspond to the direction of the market index. If index falls, so does the corresponding dividend per share.

Annual Dividend Yield per year averages 3%

One interesting thing i didn’t realize is that the dividend yield for most year is around 3%. The problem with individual dividend stocks is that you have to continue to prospect your existing business or new businesses when the business gets overvalued. You don’t want to purchase an IPAD for $2000.

So its really good to know that the dividend returns whichever year you get invested is usually around that range. This is not a guarantee. This is just an observation!

Reinvested Dividends and Returns

The last 2 columns tries to replicate what Jesse attempted to do in the article. Starting with 1000 shares, what if the wealth builder reinvest all of the dividends.

At the end of 2014, the value of all the dividends reinvested actually ends up higher than the starting price, which is at the peak of the past 14 years.

If you look at the column the right, the index growth and dividend growth are all negative compounded, so to eek out a 1% compounded growth in market value is rather good.

Will this correspond to Jesse results? We are not sure. This result will not make a lot of fans to put their money in STI ETF. They can get more returns from insurance endowment policies.

However, this is a long consolidation, I am not making prediction, but if it ends up breaching the old highs some years down the road, you would be happy that you have more years to accumulate at these lower prices.

If we view the full data from 2002 to 2014, the reinvested total returns look rather respectable.

Sans a few years, majority of the annual dividend yield is around 2.8-3%. (I really don’t understand why 2005 it was that low)

Summary

Is this applicable to individual stocks? This is more applicable to a basket of stocks such as the STI because weak performers get replace while sometimes its hard to find a company that continues to be around for decades. You always have to continue to prospect the business, value and risk.

I hope this article lets readers understand that there is a reason why Warren Buffett wants the share price of IBM to remain low. It is that he understand he is holding on to something whose intrinsic value is much higher than current price. If its an IPAD selling for $100, many would be snapping it up. The situation is similar to IBM or a basket of quality Singapore companies.

I run a free Singapore Dividend Stock Tracker . It  contains Singapore’s top dividend stocks both blue chip and high yield stock that are great for high yield investing. Do follow my Dividend Stock Tracker which is updated nightly  here.