Numbers don’t lie – Relying on Australian shares for great returns and building wealth doesn’t work

I’m that annoying little jerk who was 14 years old and knew exactly what he wanted to do when he got older. Even as a teenager, I was trading shares and buying bonds, and I even learned some early lessons – I lost a little money in the Estate Mortgage collapse of 1990.

And because I grew up in Australia, I was only ever researching, talking about, watching, and trading Australian shares. The reality is, every country on the planet has home-country bias. Every single one. But only one can afford it.

The United States.

Literally, no other country can afford their home country bias, and certainly not Australia. We represent around 2.5% of the global market cap. Yet, far too often I see a local client’s statement, or an SMSF statement, it is 100% Aussie stocks.

I understand the bias to a large degree. Not only are these companies that you know, that you see, that you call on, that you use, that you shop at, but the tax regime is such that if the company pays a dividend, there’s a good chance you’ll get that dividend tax-free. Worst case, you’ll pay a little tax.

I’m going to set aside the efficacy of dividends. Mega-litres of ink have been spilled arguing that paying large dividends is a poor use of corporate cash, and just as much has been spilled arguing the complete opposite. I’m not going to add to it, but I am going to use hard facts, data, and numbers to demonstrate that if you have a typical dividend income portfolio with no tax due at all, you’re underperforming and you’re leaving money on the table.

To be clear upfront, there are investors who solely (or largely) want income, or who regardless of growth potential, want to allocate a portion of their capital to income investing. This piece is not aimed at you. This piece is specifically aimed at the many people I come across who are convinced that investing in fully franked dividend paying listed Australian companies delivers growth and builds wealth over time. It is aimed at people who get told by advisers that they need not look further afield than the ASX 200. And importantly, it is aimed at people who solely have Aussie shares in their super funds and SMSFs, that should exclusively be about growth and about total return.

To be additionally clear – most investors should be aiming for the highest risk-adjusted TOTAL return. They shouldn’t care whether it comes from income or price, and by focusing on income, to reiterate, investors are underperforming and leaving money on the table.

Here goes.

Let’s start with some very simple charts – I’m going to pull three out of a Goldman Sachs report from earlier this year:

This chart compares the price growth of the ASX 200, MSCI World, and S&P 500. For whatever it is worth, if the Nasdaq was on this chart, it would be 14.5%. All these numbers are per year, every year, for the 10 years ending 2022. But many Australians that I show this chart to say a similar thing – where’s the dividends?

No problem - this chart adds the income component and delivers the total return of the ASX 200, MSCI World, and S&P 500. Again, if the Nasdaq was on this chart, it would be 15.5%. This explodes the myth that you’re better off in franked dividend paying Australian stocks. Even if you gross up the dividend, the Australian return caps out at around 10%. Far shy of 12.5% and 15.5%, especially given that’s an annual number, year after year, for 10 years. Now look down – this is the reason why.

Over the last 10 years, in total, earnings per share in the ASX 200 is up 51%. It’s up 167% in the S&P 500. And almost 300% in the Nasdaq. There’s your “why?”. For all their apparent faults, you have to hand it to Americans and to American companies – when they see an opportunity, they’re all over it. And corporate profits are no exception. If there is growth, if there is income, if there is profit, they will find it, and they will extract it. And when they do that, those earnings very often end up in the S&P 500 and/or the Nasdaq.

This is one of the reasons I have been, and continue to be, reluctant to allocate to emerging market stocks. Every time I hear that a large population centre (pick your poison – China, India, Brazil, MENA, etc.) is the next place to get money to work, I chuckle.

I chuckle because of that chart above – a US company (Apple, Microsoft, Lockheed Martin, Dow Chemical, Eli Lilly, Proctor and Gamble) is going to go into that market and do everything it can to capture the available earnings, and to accrue those earnings to either the S&P 500, the Nasdaq, or maybe both. And their track record of doing that is very good.

Note that these charts end in 2022, but in 2023, the return disparity is even more stark. The ASX 200 is up 4.76% year-to-date as at the writing of this piece. The S&P 500, on the other hand, is at nearly 19% total return, and the Nasdaq at over 36%. The story continues…

Now, someone may assert to me that these returns are driven by cheap money, low interest rates, Europe at ZIRP, global central bank QE, and so on. That may be true, but in that case, ALL global returns benefited from the same thing. Yet US markets were able to outperform.

Another argument I hear from the “dividend-istas” is that if you pick the right dividend payers, you’ll outperform given the size of the dividend, and the benefit of the franking. As at the writing of this piece, here below is a table of the top 20 gross dividend payers, so including the benefit of the franking credit, in the ASX 200.

Some large and well-known companies are on this list – Woodside (ASX: WPL), Incitec Pivot (ASX: IPL), Bank of Queensland (ASX: BOQ), and Insignia (ASX: IFL) amongst them – so whilst they aren’t the really large payers (the really big miners and the really big banks), they still represent significant dividend payers in Australia.

The average gross yield (so again, including the franking credit) is very solid, at 14.99%, but the average 1-year price return is distinctly awful, at -13.21%, for a grand total return of less than 2% for the last year.

Whilst the list above does include some large and well-known companies, the reality is that not many of these companies will be widely held by Australian dividend investors. Let’s then look at a different set of companies - let’s take this list, exclude every company smaller than A$5B of market cap, and then we’ll add the big and very widely held dividend payers. Namely, let’s add Fortescue Metals Group (ASX: FMG), Rio Tinto (ASX: RIO), BHP Group (ASX: BHP), and all four big banks – ANZ (ASX: ANZ), Commonwealth Bank (ASX: CBA), National Australia Bank (ASX: NAB), and Westpac (ASX: WBC).

What do those numbers look like? Well, they do look better…..but they don’t look good.

Your average gross dividend yield (to reiterate, that includes the benefit of the franking credit) is 12.05%, so still very good. Small problem – you lost 7.80% in value over the same 12-month period. Your total return is a paltry 4.25%.

The reality is that not only CAN investors work with both dividend and price, they SHOULD. And when you do that, it becomes quite evident that Australian dividend stocks are relative underperformers. To contrast the data above, because I keep doing this, the S&P 500 is up around 14%, and the Nasdaq around 28% (no typo) over the same 12-month period. A somewhat typical 50-50 mix of the two delivers 21% over those 12 months, and with essentially the same level of volatility as the ASX 200.

A critical thing that evangelical dividend investors often miss is that when the corpus of the capital stays still, or even worse goes backwards, the base from which you’re building your wealth is staying still or worst case, going backwards. Price action matters so don’t disregard it, as many dividend investors either explicitly or implicitly do. If your principal corpus is falling, even if the percentage dividend yield is stable, the dollars that yield turns into, because the corpus is potentially smaller, may be falling.

Read that again - as an income investor, your income is potentially falling. Not good!!

Even when income dollars are stable or rising, dividend investing rarely builds wealth because it is almost solely focused on generating fully franked dividends. Even if your plan works, here’s what happens – you generate dividends, and those dividend dollars get paid out to you. And you spend them.

One of the real beauties of investing is that time in the market beats timing the market. When you let compounding do the work, the results are amazing. But there is regularly no compounding with dividend investing. Had you been invested in Australia for the last 16 years, your corpus has gone exactly nowhere, and your entire return was paid out to you and almost certainly spent.

You generated income, no doubt, but you didn’t build any wealth.

In days gone by, it was very hard and very expensive to get access to international markets. But today, given it’s as easy to get access to global markets as it is to get local access, there’s little reason for Australian investors to not switch at least part of their portfolio to total return investing. The comparison that I am making between Australian stocks and US stocks should loom large in the minds of investors who are trying to grow their investment balances, and therefore their wealth.

And in particular if an investor is using a SMSF because in that instance, not only do you likely have an extended time frame, but the tax concessions mean that you should be agnostic between receiving your return in dividends or in price. In fact, I’d argue you’re significantly better off to receive as much of your SMSF return in price as possible because it means you don’t have to take any steps in terms of reinvesting. Plus, even if you do set up dividend reinvestment in Australian stocks, the reality is that you just bought more of a stock that is likely to not grow.

In the end, investors must decide what the end goal of their investment actions are. Some people just want income, and if that is genuinely the case, then Australian stocks might be for you. But most investors want the highest possible return, or maybe risk-adjusted return.

In trying to achieve that superior return, many investors go to an adviser. And unfortunately, some of those advisers have (I believe) underserved their clients by telling them that all they need is fully franked Australian dividends. Look at your statement, right now. Stop reading and come back here after you’ve checked your statement, or your SMSF, or both.

The most appropriate investment return is derived by looking across the entire available investment landscape, short-listing the ideas that align with what it is you’re trying to achieve, and then selecting the pieces that work, and in some part that comes down to risk-adjusted returns. I’m hopeful this piece has been useful to investors who are doing just that but have been advised to do it only in Australian shares (BTW, don’t even start me on residential real estate!!!). The reality is, US markets have historically delivered significantly better total risk-adjusted return than Australian markets, and they will very likely continue to do so. Ignoring that point, I think, will lead to significantly lower returns over time that in some cases are potentially life-changing.

Good luck out there.