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Hedging inflation ….

For my first post (which has been a long time coming!), I thought I touch on the Australian stock market returns. We’ll look at whether returns from the ASX keep up with inflation (inflation adjusted returns – which are not frequently cited) and what portion of returns is made up by dividends. I’ve used the ASX All Ordinaries index as a proxy for stock market returns.

Investment returns can be measured in many ways but the ones I like are CAGR (compounded average growth rate) and IRR (internal rate of return). As these returns are calculated on an annualised basis, it makes relative comparisons a whole lot easier. CAGR is good for measuring returns when the investment transaction is a straight forward buy and sell with no interim transactions during the holding period; whereas the IRR is more flexible as it can accommodate other interim transactions during the holding period such as dividends, rights issue etc.

I have charted the long term returns for the ASX All Ordinaries index over a 79 year period from December 1935 to December 2014 on an inflation adjusted basis (real basis – index based on December 2014 dollars).

ASX long runThe CAGR for the above period on a real basis is 0.9%. Before you say that can’t be right, bear in mind that this is just the returns solely based on the price action. To give a sense of the returns based on a nominal basis (i.e. not adjusted for inflation), the nominal returns over the same period was 5.9%. Although inflation eroded approximately 5% of returns, returns from stock prices alone was able to keep up with inflation and produce a real return of close to 1%.

The next natural question would be what if we included dividends, how much more would it add to the returns? This can easily be done by looking at the All Ordinary accumulation index, which is a total shareholder return index assuming that all dividends are reinvested. However, data only exist for the All Ordinaries Accumulation index from 1979.  The chart below compares the price return and the total return indices on a real basis.

ASX AccumulationAs seen above, dividends make up a large portion of returns, how much you ask? Well without dividends the real returns over the above period were 2.7% (price index), whilst the total return including dividends was 7.0% (accumulation index). Based on the above period, dividends accounted for a whopping 4.3% of the overall returns.

So the takeaways from this analysis are:

  • Solely based on the price action alone, returns from the stock market over a 79 year period to December 2014 was able to produce a 1% real return and over a shorter period (35 years to December 2014), the real return based on movement in stock prices was 2.7%.
  • Dividends (reinvested) make up a significant portion of returns. Over a 35 year period to 2014, dividends (reinvested) made up 4.3% of real returns out of the total returns of 7.0%.
  • This suggests that in the long run the stock market is a good hedge for inflation and don’t forget to reinvest those dividends !