If you're investing in dividend–paying shares because you need the income, then by all means take it, Matthew Carr in Wealthy Retirement
If you don't, then there's no real reason not to have those dividends reinvested.
Because even though you might not think it does, it impacts your returns. And it's better to have those dividends doing something other than gaining a fraction of a percent in interest in an account.
Let's take a look at an example.
Let’s say you invest in a solid dividend paying company, Divi Ltd. It pays a dividend yield of under 3%.
Over the last ten years, Divi shares have averaged a return of about 10% per year. Its best year was 2006, when Divi shares rose 35.8%. In its worst year, being 2008, shares lost 15.2%. Since then, Divi has had one year of double-digit returns in 2011 of 15%.
Let's say you put R5,000 in Divi shares at the beginning of 2006. You got 87 shares for R57.45. That's not bad. Let’s say the shares are now trading at R97.85. Just in terms of price movement, that's a gain of 70.32%.
But there's a real difference between if you had reinvested the dividend or just took the cash and let it sit there.
The five-year average dividend yield on Divi is 2.4%. It has raised its dividend from an annual rate of R1.28 in 2006 to R2.52 today.
Since 2006, if you'd just taken the dividend and not reinvested it, your initial R5,000 investment would be worth R8,516.70. Plus, you'd have another R1,226.28 in cash dividends collected for a total amount of R9,742.38. That would give you a total return of 94.85%.
Again, not bad.
But you'd still own only 87 shares. If Divi doesn't raise its dividend beyond the R2.52 annually that it pays now, you'll collect another R219.24 in 2014.
The power of reinvesting your dividends
On the other hand, if you'd reinvested those dividends since 2006, your current gain would be 104.09%, almost 10% higher.
You'd own 104.29 shares worth R10,204.71.
Plus, those 104.29 shares will pay you R262.81 in dividends next year. And that's if the company doesn't raise its dividend beyond the R2.52 level it's at now.
So, by reinvesting the dividend:
You increased your total return by nearly 4.5%...
You now own 19.87% more shares...
And your annual pay-out for 2014 is expected to be 19.87% more...
That may not seem like too big of a variance, but over time it continues to add up. That’s the compounding
The more time you have to get your dividends working for you, the more powerful - and impactful - it becomes to your portfolio.
But the longer you let dividends go to waste, just piling up with no real direction, the more gains you're wasting.
So there you have it, why you should reinvest your dividends.