Excerpted from Bogle on Mutual Funds by John C. Bogle, pages 32-34
The volatility of capital returns, as distinct from total returns, is a subject given too little attention by investors. In the short run, the two risks are similar. That is, variations in stock prices tend to overwhelm the steady dividend component of total return over periods of one or two years. But in the long run dividends, through the magic of compounding, not only become a key contributor to total return but also provide a dollar-cost averaging effect as they are regularly reinvested.
Standing on their own, principal returns on stocks vary enormously. In a worst-case example, $10,000 invested at the 1929 stock market high would have fallen to $1,400 at the market low in 1932 and would not have returned to its original value until 1954. The capital investment - measured at market value - of this unlucky investor was underwater for 25 years.
Put another way, absent the compounding of income, the principal risk of your investment increases because it reflects solely the rate of capital return. Without the income effect, the productivity of your assets is diminished disproportionately, since merely adding up returns is far less productive than compounding them through reinvestment. Table 2-5 shows the results of an investment in the stock market during an average decade in the 1926-92 time span. The top portion of the table is divided into the principal and income components of the investment. As you can see in the lower portion of the table, the final value, assuming dividends were reinvested, increases by $5,330 - more than 50% of the amount initially invested.
