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.