If you’re just starting out as an investor or still have plenty of years left in your investing lifetime, you should consider using a dividend reinvestment plan or DRP for some or all of your holdings.
Should You Reinvest?
Reinvesting dividends will be circumstance dependent on what stage of life your’e in. You might be using the money to live off or pay bills, or you might not need to touch it for a very long time. Everyone’s position in life is different.
I happen to fall into the position of not needing the money for a long time, so I’m happy to setup the dividend reinvestment plan for all my holdings.
There is really only two options with a dividend or distribution you receive from a company or a fund. You can either take the cash payment straight into your bank account or you can setup with the company or share registry to have them automatically reinvest the money and buy you more shares of the company or fund you own.
I have read multiple times that reinvesting your dividends will accelerate your returns down the track… Is this statement true? I wanted to find out to be sure.
I decided to run a backtest in excel to see if this was true or not. The plan was to use a consistent monthly investment strategy while reinvesting all the dividends over a 10-year period.
The test period was from February 2010 to December 2019, the stock chosen was Westpac Bank (WBC).
I had to source important information like the divided per share and the share price if I wanted to reinvest. To get all this I went onto Westpacs website which had all the historical information I was looking for.
I started the test with an initial $500 tranche because that’s the minimum amount you can buy in Australia, and I wanted a manageable amount for anyone to invest each month so I went with $150.
So how were the results from the backtest?
The results to me were outstanding and show that reinvesting your dividends works (it also shows how important your savings rate is to grow your money at an even faster clip).
The image below was the outcome at the end of last year. The blue line is taking cash payments into your bank account and the green line is having the dividends paid buy more shares, you can see compound interest start to work its magic over time with the gap widening each passing year.
The overall return at this point was 6% annualized. Of course there’re better returns available out there but for a steady investment strategy I don’t think many people would complain about this.
For full transparency I haven’t factored in the average purchase price from dollar cost averaging into the market. This was just to show the difference what reinvesting dividends would have done at the end of a 10-year period (it ended up being 9 years but close enough).
That was at the end of 2019, what about now mid-April 2020?
The screenshot below shows what the value would be present day, still very impressive to me.
From your actual cost basis, you would only be down 8%. However, if you hadn’t reinvested any dividends and just taken cash payments for every payout, you’d be down a massive 44%.
This was a big eye opener, compounding is a slow at first but picks up steam as time goes on. A 9-year period is only a short amount of time… but these results were enough for me to believe that over time using a dividend reinvestment plan will achieve superior results as time goes on.
Values of Holdings April 20
The total money spent over this time period including fees was $18,795.25, current value of holding with all dividends reinvested would be $17,153.37 and the current value of holding with no dividends reinvested would be $10,458.18.
I think I’ll run a few more tests like this with ETF’s and LIC’s and see how they turned out over a 10-year period.
Current Dividend Yield
The total cost basis for this holding at the end of 2019 including all fees was $18,347.25. The stock paid $1668.90 in dividends during 2019, making the total dividend return 9%. The function behind getting a higher growing yield over time is thanks to Westpac raising their dividend per share over time.
Now to be fair Westpac could cut or suspend their dividend and your 9%is now down to 4% or 0% so there is that risk of course.
But no one ever knows what’s going to happen next ,and investing in good income paying assets can be that easy. A consistent passive investment strategy over the long term will achieve great returns. The key words there are consistent, long term (5 to 10 years plus) and good income paying assets.
The trick is in find those assets which can be easy too if you know where to look.
What do you think, is it better to reinvest your dividends or take the cash? Let me know in the comments.