Should I reinvest dividends?
When a company or fund issues dividends shareholders are
often given the option to participate in Dividend Reinvestment Programs or
DRIPs. DRIPs allow dividends to be paid out to shareholders in additional shares rather than cash.
DRIPs enable investors to leverage the power of compounding interest
because:
- Additional shares purchased have the potential to continue to appreciate and if held generate future dividends
- Shares issues via DRIPS are issued without trading fees
- Fractions of shares rather than whole shares can be purchased
- DRIPs automate investing
Whether or not you should participate in DRIPs depends on
your financial situation
- Do you need the income that comes from DRIPs to live on? If so you’ll want to take your dividends in cash.
- DRIPs can throw off your portfolio’s asset allocation because new shares are issued in the same asset. This can push your allocation out of balance.
- If you would prefer to use the cash to purchase shares in a different asset-DRIPs may not be right for you
Let’s take a look at the impact of dividend reinvestment on
a $1000 investment over a 30 year period.
The asset has a total 10% annual average return over a 30 year period-8%
of which was due to capital appreciation and 2% dividend yield. The red line shows the asset’s return without
dividend reinvestment. It includes the
capital appreciation on the asset as well as all cash received by the investor
over a 30 year period, $10,249 or a total 102.49% return.
The blue line shows the impact of dividend reinvestment on
the initial $1000 investment over a 30 year period. The final value of the investment is
$12,328.32 or a 123.28% return! As you
can see a 2% dividend yield may seem small but can have a real impact to your
portfolio’s return over a long period!
Take a look at total return of the S&P 500 since
2011 which includes dividends. The total return (Ticker: SP500TR) was 131.75% vs.
97.45% that’s a 34.3% increase in returns over the base capital appreciation of
the S&P 500 (Ticker: .INX) all due to dividends!
Google Finance |
Participating in dividend reinvestment programs enables you to take advantage of the power of compounding interest. Though you need to take your personal financial situation into account it can be a powerful tool to ensure your financial future.
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