We have covered dividends several times but today we are going to explore a different aspect; dividend reinvestments.
Before we dive in, let's go over what a dividend is. Simply stated, a dividend is a distribution of a company's earnings to its shareholders. It is seen as a reward paid to the investors in the company.
The amount a company pays out relative to its stock price is referred to as the dividend yield. Quick example - a company is paying $5 in dividends for each share you own. Each share trades at $100. The dividend yield would be 5% ($5/$100).
Dividends are typically paid out 4 times a year. Using the example from above, every 3 months you would receive $1.25 for each share you own. Let's say you had 100 shares totaling $10,000, you would receive $125 each dividend payout, or $500 per year.
Now you can simply take the cash and consider it an additional source of income. There's nothing wrong with that, people do it all the time. Or, and this is what we recommend, you can turn on that DRIP.
DRIP stands for dividend reinvest plan and is a feature in your brokerages account settings. It automatically reinvests those dividends for you.
That means the brokerage takes the $125 and buys more shares of the company on your behalf. That first dividend, you would be able to purchase 1.25 additional shares of the company. But here's where it gets interesting. Assuming no price fluctuation, you now have $10,125 worth of stock so your dividend increases to $126.56 the next quarter.
Every quarter you continue to buy more shares with your dividends, your money compounds and you receive more dividends. As Albert Einstein says, "compound interest is the eighth wonder of the world" and we fully agree. This is why we definitely recommend reinvesting your dividends.
We plugged some parameters into a dividend calculate using the same example from above, no additional contributions, a 7% annual returns on the stock and a 5% annual dividend increase:
Here is how much your stock would be worth after 20 years if you didn't reinvest:
Your shares would be worth $38,697 and you would have received $37,520 in dividends over the course of 20 years.
Next, we used the same parameters and chose to reinvest the dividends. Here is what you would have:
Your shares would be worth $192,180 and you would have received $112,306 in dividends over the course of the investment.
That's a pretty spectacular difference if you ask us.
Too many numbers? More of a visual person? We don't blame you, we are the same. Let's look at our Instagram post which uses the same example:
If that graphic doesn't convince you, we don't know what will.
By not reinvesting dividends, your investment would only be worth $38,697 and you would receive $37,520 in dividends over the course of 20 years.
If you do reinvest the dividends, your investment would be worth $192,180 after 20 years and you would be receiving $22,281 in dividends that year alone.
Now the initial 5% yield may be high for most stocks nowadays, so we also plugged in a lower yield to show that reinvesting still makes sense. Here is a stock with an initial dividend yield of 2.5%:
Reinvesting still wins.
The conclusion is simple - turn on that DRIP and reinvest your dividends.
Thanks for reading and have a great day!
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I am not a licensed financial advisor or financial professional. This is not investing advice. I am simply sharing my research and opinion based on that research. It is very important that you do your own research and make investments based on your own personal circumstances, preferences, goals and risk tolerance.
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