Dividends: Theory and Empirical Evidence

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Building on the concepts presented in my article, Dividends Are Different, here I present data and observations highlighting how dividends can protect investors from inflation and market volatility. While this content is relevant to other applications, I focus on it within the context of retirement income.

When designing portfolios to provide for retirement, conventional wisdom holds that allocations to stocks generally facilitate growth that helps hedge against inflation. I agree with this notion, but try to make it more concrete by highlighting the fundamental and market-based mechanics behind this relationship.

I then look at empirical data to investigate how inflation relates to market prices, earnings, and dividends. I measure results over 25-year time periods – fairly typical horizons for retirement planning. My findings reveal impressively strong relationships between fundamental performance and inflation, but an unsurprisingly weaker linkage between market returns and inflation.

Relative to chiseling away from a portfolio, dividends provide a more direct tool to combat inflation as they avoid the layer of noise imposed by often-volatile market prices. This can be especially important when inflation surfaces as asset prices may react negatively – thereby requiring higher withdrawals when asset prices are depressed. This situation can impose permanent damage on retirement security and is why retirement researchers identify inflation as such a critical risk.

Figure 1: Correlation with inflation (25-year periods since 1880)

Source: Robert J. Shiller market data, Aaron Brask Capital


This article is organized in three primary sections followed by my concluding remarks. The first section highlights theory and mechanics that relate inflation to stocks price movements. The second section quantifies these notions and presents my empirical findings. The third section discusses the potential roles dividends can play in the context of addressing and managing market risk.