Warren Buffet does not believe in reinvesting dividends. He would rather take dividends and find another company to invest the cash into. You are not Warren Buffet. He receives enough in dividends in 1 year to be able to purchase entire small cap companies.
I believe things are different for smaller investors and there are several benefits we can reap from reinvesting our dividends. Here are a few:
Micro Dollar Cost Averaging
Dollar cost averaging is basically what you do when you are contributing into your 401(k) each pay period. Systematically purchasing shares of an investment at a fixed contribution level to mitigate the daily fluctuations of a change in value of an investment. In other words, you are purchasing a few shares of an investment over the course of time. Doing so, reduces chance that you invest a large lump sum of money at the high price of an investment.
Reinvesting dividends is kinda like dollar cost averaging but on a smaller level. Initially, you make your stock purchase. The subsequent quarterly dividends are then reinvested and at various random prices based on when the dividend is paid out. Not reinvesting the dividend will simply accumulate a little cash for you. Unfortunately the cash dividend you receive won’t be enough to purchase a small company like Buffet would be able to do.
Slowly Accumulate More Shares
This goes hand in hand with the above, but it’s worth pointing out. By reinvesting your quarterly dividend from your stock, you are also slowly accumulating more shares in the company. Stay with me here. I’m going to show you a little example on why this matters in a bit.
Free Stock Transaction
This becoming less of a thing for retail investors as Schwab fired shots a couple months ago and eliminated the trading cost to purchase domestic stocks. But not too long ago, you used to have to pay to invest your money in stocks. It wasn’t much money to purchase a stock, but you might have to pay anywhere from $5-$10 to purchase a stock, regardless of the amount transacted. However, most reputable discount brokers would reinvest your dividends for free as their platforms evolved over time. In economics class, the professors would always teach you on day 1 the acronym TINSTAFL, “there is no such thing as a free lunch”. Well, sometimes, some things can actually be free…dividend reinvestment. If you are paying to reinvest your dividends, it might be time to look elsewhere for your stock investing.
Get Paid to Wait
If your stock does nothing or even decreases in value, the dividend effectively pays you while you wait. Keep this in mind as I get to my example later below. Just remember there was a time when Wall Street turned it’s back on MSFT.
Less Decisions for You as an Investor
You have options that you can do with your dividends: reinvest the dividends in the same company, spend it, save it, invest the money in something else. As you accumulate more and more stocks are start to really build your dividend income, the decision can become harder when trying to decide what to do with your dividend. Reinvesting your dividend gives you one less thing to have to make a decision on.
Easily Grow Your Dividend Income
By reinvesting your dividends into the existing position, you accumulate additional fractional shares, as mentioned above. What I would encourage you to do, is to track your dividend reinvestment, information such as shares purchased, the purchase price, and the total value reinvested. As you track this data, you should see that each subsequent quarter, the amount of dividends you receive from that investment is slowly but surely increasing over time. It’s like getting a little pay raise every quarter, and best of all, you don’t have to work for it.
If compounded growth is the eight wonder of the world according to Albert Einstein, I think even his mind would be blown at the concept of double compounding. Now I don’t believe there is any official terminology about double compounded growth if you search the internet, but it’s something I noticed happening to my dividend income as my brokerage accounts opened up dividend reinvesting. As mentioned in the bullet point above, this was something I noticed by tracking my dividends.
Here’s how it works. Take the above concepts from above. You reinvest your dividends in the position. By reinvesting the dividend and purchasing additional fractional shares, your next quarterly dividend amount naturally increases. The double compounded growth comes from investing in a dividend growth company (basically a company that increases their dividend in a controllable and highly predictable manner-think JNJ or KO).
Now, you have the basic mechanics from having the regular quarterly dividend reinvested, but also you pick up the tailwinds from having the company increasing how much they are paying you.
Don’t believe me. Let’s take a look at this and put in in action. By the way, this is information from one of my own personal accounts.
Putting It All Together
Lets look at the above spreadsheet. The data on the left shows my position in MSFT that I opened in my Roth IRA, purchasing 100 shares at a price of $26.85. I received just a cash dividend in the stock until my brokerage company started their dividend reinvestment program in 2008. Since then, I have been reinvesting the fractional amounts of dividends back into Microsoft.
With dividend reinvestments since 2008, I have accumulated an additional 32.17 shares in Microsoft. Also notice my first dividend received when MSFT started paying a dividend in in 2004 of $8 per share/quarterly (the 12/2/2004 dividend included a special dividend payment). Fast forward to present day and I am now receiving a quarterly dividend in the amount of $67.21. This represent a 740% increase in the dividend income from this position in MSFT. The total value of my position in MSFT in this account currently sits at $21,900.57 with dividends reinvested.
Now lets look at the right side data. This represents an alternate timeline where I do not reinvest dividends at all. If I went down this path, I still have just 100 shares of MSFT purchased at $26.85. I would not accumulate any additional shares, but I still receive the cash dividend. The dividend starts at $8 and at present day I would be receiving a quarterly cash dividend of $51, representing a growth in dividend income of 637%. Impressive, but realize it is $16.21 less when compared to the Q4 dividend on the left side of the data. Also notice the present value of the position in MSFT would be lower at $16,570. This is $5330.57 lower in value due to not reinvesting the dividend. Assuming we didn’t just spend the dividend, lets assume we sat on the MSFT dividends in cash throughout the years and add that back to the position. We end up at $18,308 in value from MSFT based on the position value plus cash dividends received through the years, still lower by $3592.57.
Comparing the amount of dividends received through out the years, we see a total of $2000.46 received with reinvesting vs $1738 by purely receiving cash dividends.
For a number of years at the turn of the century, MSFT was a despised stock on Wall Street. I purchased in and waited, collected dividends, reinvested and stayed put. Fast forward, they are the second largest company by market cap, and analyst have several buy ratings based on cloud growth. While I waited, I accumulated. This is just one example of my that I personally have.
To me dividend reinvesting is a no brainer. Especially during your working years. While you are working, you shouldn’t need the dividends to live off, so it’s best to reinvest your dividends during these years. Need some motivation. Check this out. This shows my personal dividends I’ve track going back to 2008. Back in 2008, I was receiving just over $2000 in dividends for the year. With patience, in 2019, I received just over $29,500 in dividends and for 2020 will get around $33,000 in dividends.
As you transition to retirement/semi-retirement you can slowly start to not reinvest your dividends and live off the dividend income. This is what I have done, but still reinvest a large majority of my dividends.
If you are not an individual stock investor, no worries. Even with ETF’s you can do a lot of the above principals.
Something I did not get into today is yield on cost. Basically what are the current dividends I receive annually from my stock, divided by my initial stock purchase. To read up more on this important topic read this article, which has been featured in a couple of places. But to summarize that article, my initial dividend yield on MSFT was 1.19%. My current yield on cost of the stock sits at 7.59%. With patience, I am basically making a 7.59% (and growing) return per year on my initial investment in MSFT.
While a normal person will never be able to purchase entire companies with their dividend income stream, I regular retail investors should consider reinvesting their dividends for many other reasons.Follow me on the social medias: