The S&P 500 index is the market's go-to benchmark. Because it tracks 500 of the largest and generally most successful companies in America, it's used as a proxy for the health and performance of the overall economy and stock market -- and therefore the health and performance of everything from small caps to large caps to mutual funds.
And you can supercharge that performance.
Step 1: Invest
David and Tom Gardner, the founders of The Motley Fool, argue that every investor should aim to at least match -- if not beat -- the market. And the easiest and least-risky way to do so is to invest in an S&P 500 index fund.
An index fund is a passively managed mutual fund or exchange-traded fund (ETF) that simply buys shares of every company in the S&P 500. Because the fund is made up of the same components that comprise the index itself, its performance is equivalent to the performance of the index.
Almost. An index fund will underperform the index by the amount you have to pay in fees. The venerable Vanguard 500 Index (VFINX), for example, has a total expense ratio of 0.15%, while the iShares S&P 500 Index ETF (IVV) sports an expense ratio of just 0.09%. The Dreyfus S&P 500 Index (PEOPX), on the other hand, has a total expense ratio of 0.50% -- and losing to the index by half a percentage point per year will add up.
In other words, the lower the expense ratio, the more closely you'll track the index itself. But you'll always underperform, albeit slightly.
So what can you do?
Step 2: Compound it!
If you want to maximize your S&P 500 index fund returns, all you have to do is reinvest the dividends. It's that easy.
For instance, the SPDR ETF that tracks the S&P 500 was launched in January 1993. Had you bought $1,000 worth of that fund when it launched, those shares today would be worth $2,921 -- and with the dividends you'd received over the years, you'd have a total of $3,505. But if you had reinvested dividends along the way, you'd have $3,822.
That may not seem like a big difference, but you'd have outperformed the index by nearly two percentage points annually -- and with larger sums and more time, that difference will add up in a significant way.
In other words, simply by reinvesting your dividends in the same index fund, you'd own more shares and they'd be worth more than if you'd taken the cash along the way.
Can you do even better?
Investing in a low-cost index fund and reinvesting the dividends is a smart way to invest for the long term -- but you can do even better.
The S&P 500 index contains many stocks that don't pay dividends at all. Thanks to the tremendous boost those payments give your returns over time, you could supercharge your returns by an even larger margin by buying solid companies with strong dividend policies and histories.
The well-known companies in the table below, for instance, were all paying dividends well before the SPDRs ETF was even launched. Check out the advantage you'd have gotten by investing in them over that same period of time and reinvesting their dividends.
|
Company
|
Returns With Dividends Paid Out
|
Dividends Paid Out
|
Returns With Dividends Reinvested
|
Difference With Reinvestment
|
|
SPDRs
|
$2,943.79
|
$561.36
|
$3,822.40
|
$878.61
|
|
PepsiCo (NYSE: PEP)
|
$3,324.74
|
$903.04
|
$4,632.07
|
$1,307.33
|
|
Automatic Data Processing (NYSE: ADP)
|
$3,518.88
|
$1,328.71
|
$4,698.54
|
$1,179.67
|
|
General Electric (NYSE: GE)
|
$4,143.99
|
$1,092.02
|
$5,936.13
|
$1,792.14
|
|
Emerson Electric (NYSE: EMR)
|
$4,245.06
|
$1,092.80
|
$6,295.10
|
$2,050.05
|
|
Abbott Laboratories (NYSE: ABT)
|
$4,282.18
|
$653.53
|
$6,413.94
|
$2,131.76
|
|
Johnson Controls (NYSE: JCI)
|
$10,244.20
|
$1,000.72
|
$13,954.17
|
$3,709.97
|
|
Aflac (NYSE: AFL)
|
$13,372.80
|
$938.56
|
$15,695.77
|
$2,322.97
|
Of course, not every company is going to wind up trouncing the market the way these have. Even so, evidence collected by well-respected researchers such as Jeremy Siegel suggests that dividend stocks are the best stocks you might actually buy.
At Motley Fool Income Investor, we believe in the tremendous wealth that reinvested dividends can provide. Since our dividend-focused service began, our recommendations are beating the market by seven percentage points. If you'd like to see what dividend payers we're recommending now, take the next 30 days to try us out for free.
At the time of publication, Fool contributor Chuck Saletta owned shares of General Electric. Aflac is a Motley Fool Stock Advisor pick. The Fool owns shares of SPDRs and has a disclosure policy
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