STRATEGIES

Over long periods, dividends, dividend growth, and compounding can produce investment returns that most people wouldn't think possible, writes John Heinzl of Globe Investor.

In a column two weeks ago, I examined the long-term financial returns of owning a cottage versus investing in Royal Bank of Canada (RY) shares.

The analysis revealed that the cottage in question—which a reader purchased in the mid-1970s for $26,000, and which today is valued at approximately $250,000—had an annual return of about 3% after taking into account renovation expenses, maintenance costs, and property taxes.

That paled next to an investment in Royal Bank shares, which—assuming all dividends were reinvested—would have grown to more than $1.2 million from March 31, 1975, to the end of 2012, for an annual return of 10.8%.

At least that's what I thought. But as a sharp-eyed reader pointed out, the analysis vastly underreported the actual return in Royal Bank's stock.

It turns out that Bloomberg, which was the source of my data, included just three stock splits for Royal Bank over the 37.75-year period. In fact, the shares split four times.

When I contacted Bloomberg and had them correct the data, the picture changed dramatically: Royal Bank's total return, including dividends, jumped to 12.9% annually, and the initial investment of $26,000 soared to more than $2.5 million.

But even that number may not be high enough. The reader, who wishes to remain anonymous, sent me a detailed spreadsheet documenting every dividend Royal Bank has paid since March 1975, and tracking the growth of the initial $26,000 assuming each dividend was reinvested in additional shares.

Assuming the reader's calculations are correct, the Royal Bank investment would have soared to nearly $4.5 million by the end of 2012. I could not verify all of the data in the spreadsheet, but I randomly checked many of the numbers, and they were accurate.

Granted, an investor would have had to pay taxes on every dividend received, but even assuming a 20% tax rate on dividends, the total would be a still-impressive $3.2 million—equivalent to an annual return of 13.6% (before capital gains taxes).

What about inflation, you ask? Well, the consumer price index rose at an average annual rate of just under 4% over the period, according to the Bank of Canada's Web site, so the shares produced an annual gain of more than 9% in real terms, which is still spectacular.

Curious to see whether other banks posted similar returns, I used the investment calculator available on Toronto-Dominion Bank's (TD) website.

Over the period in question, a $26,000 investment in TD Bank shares would have increased to about $5.4 million—a growth rate of more than 15% annually, which is slightly higher than Royal Bank's gross return.

The message here isn't that you shouldn't buy a cottage. Cottages produce their own rewards—family time, relaxation, memories—that can't be measured in dollars and cents.

The message is that, over long periods, dividends, dividend growth, and compounding can produce investment returns that most people wouldn't think possible. It's worth pointing out that the years from 1975 through 2012 included recessions, bear markets, financial crises, wars, and periods of high interest rates and inflation.

Keep that in mind if you're feeling rattled by this week's market volatility.

Read more from John Heinzl and Globe Investor here...

Tickers Mentioned: RY, TD

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