Dividends - Why the push to reinvest?

Question

I recently received an email from my brokerage (UK based) stating:

"Research from Barclays shows that without dividends, £100 invested in the UK stock market since 1899 would have grown into just £177 after adjusting for inflation. However, the real return soared to £28,232 if dividends were reinvested. Of course this is an unrealistic timeframe for most investors and past performance is not a guide to the future. But it does illustrate just how important dividends can be."

I've noticed a lot of push from various providers encouraging their customers to always re-invest dividends with statistics such as the above, and although I can't speak to the accuracy of the above figures, suppose that I own 10 different stocks, and don't reinvest dividends, but keep them on account, and each month or two, as I add more money to invest, either in one of my existing stocks, or perhaps something new, I add whichever dividend amount is currently available in cash to my new purchase, would this strategy provide the same results? That is, is there some particular reason that the brokers are recommending automatically reinvesting dividends as opposed to reinvesting them manually, perhaps not always in the same item?

Answer 1

A dividend is a cash disbursement from the company. The value of the company goes down the same amount of the dividend, so it is analogous to having money in a savings account and taking a withdrawal every month. Obviously you are going to have less in the end than if you just kept the money in the account.

suppose that I own 10 different stocks, and don't reinvest dividends, but keep them on account, and each month or two, as I add more money to invest, either in one of my existing stocks, or perhaps something new, I add whichever dividend amount is currently available in cash to my new purchase, would this strategy provide the same results?

Roughly, yes. Reinvesting dividends is essentially buying more stock at the lower price, which is a net zero effect in total balance. So if you invested in the same stocks, yes you'd be in the same place. If you invested in different stocks, then you would have a performance difference depending on what you invested in.

The risk is the temptation to take the cash dividend and not reinvest it, but take it in cash, thereby reducing your earning power.

That is, is there some particular reason that the brokers are recommending automatically reinvesting dividends as opposed to reinvesting them manually, perhaps not always in the same item?

I'd like to think that they're looking after your best interest (and they might be), but the cynical part of me thinks that they're either trying to keep your business by increasing your returns, or there's some UK regulation I'm not aware of that requires them to disclose the effect of reinvesting dividends.

£100 invested in the UK stock market since 1899 would have grown into just £177 after adjusting for inflation.

This figure seems ludicrous to me. I haven't actually measured what the historical returns on the "UK market" are, but that would mean an annualized return (adjusted for inflation) of just 0.5%. Either UK stocks pay a ridiculous amount of dividends or there's something wrong with the math.

EDIT

I still have not found a definitive source for the real UK market return, but according to this inflation calculator, £100 in 1899 would equate to almost £12,000 today, for an average inflation rate of 4.14 percent, which would put the CAGR of the UK market at about 4.9%, which seems reasonable. The CAGR with dividend reinvestment would then be about 9.1%, making dividend reinvestment a no-brainer in the UK market at least.

Answer 2

Good question, here are some possible answers:

Its a Good Idea There is probably some validity to the statictics and having money invested, generally speaking, has proven far more valuable than having it sit in a savings account.

It tends to reinforce strength Suppose you own two stocks, one that is a great performer, and one that isn't. Generally speaking the high performer will pay out more, and if you reinvest more into that stock, you will be wealthier if you contributed equally to both stocks.

You might forget People tend to forget to do things that are not in the forefront, and reinvestment is one of those things that slip people's mind. One of the wealth building tools that people universally recommend is automation. Reinvesting is a way to automate one aspect of one's financial life.

You might spend it on something else If you put the dividends into your checking account, there is a non-zero chance that it might get put towards something else. Better to have it out of sight and mind and invested.

They make money Generally speaking, the more money you have in a brokerage account, the more the brokerage makes. So it is good for them, as well as yourself.

While there is some attraction to being able to see a balance that is the result of dividend investments, its just far better to have them be poured right back into whatever investment seem appropriate.

Answer 3

Three major advantages that I can think of (and some of these have been pointed out in comments):

• Brokerages don't necessarily charge trading fees to automatically reinvest dividends (mine doesn't), so you can avoid trading fees
• Brokerages may give you fractional parts of stocks if you're reinvesting dividends, so you can have a higher percent of your cash invested. For example, I currently own 24.7869 shares of a particular ETF as well as 17.4542 shares of Microsoft because I have my broker reinvest dividends. This is actually a significant advantage if you're investing relatively small amounts of money because if you want to purchase a stock that costs $50 each and you're trying to invest $225, then you'll have $25 in idle cash (minus whatever fee your brokerage charges for the purchase) until you can afford to invest more money. ($25 may not sound like much, but it's still 11% of the original amount you invested in this case).
• Reinvesting dividends tends to shift your portfolio towards performing stock. If company A is giving out $2 dividends on $100 stock but company B is only giving out $1 dividends on $100 stock, then clearly A is performing better than B (all other things being equal). As a result, your portfolio will be shifted slightly towards company A.

Answer 4

There is a basis for that if you consider the power of compounding. So, the sooner you re-invest the dividends the sooner the time will give you results (through compounding).

There is also the case of the commissions, if they are paid with a percentage of the amount invested they automatically gain more from you.

Just my 2cents, though the other answers are probably more complete.

Answer 5

There can be a good reason if you own shares issued in a different country: For example, if you are in the UK and own US shares and take the dividend payments, you get some check in US dollars that you will have to exchange to UK£, which means you pay fees - mostly these fees are fixed, so you lose a significant percentage of your dividends. By reinvesting and selling shares accumlated over some years, you got one much bigger check and pay only one fee.