Reinvesting or Not Reinvesting Your Dividends
The Dividend Dilemma Every New Investor Must Face
One of the most important questions you will face as a new investor is whether to spend the dividends you receive from your stocks on things like cars, vacations, or living expenses each year, or whether you should reinvest them for future growth.
Your choice could have an enormous influence on your ultimate net worth, as well as how much enjoyment you get out of your capital along the way.
To gain an understanding of the trade-offs, the following example looks at an investment in a real-life company. By illustrating the possible outcomes in this scenario, you'll be better equipped to decide which approach will work for the portfolio you’ve put together to help your family reach its financial goals.
An Example: Don’t Reinvest the Dividends
Say that you as an investor put $10,000 into shares of The Coca-Cola Company in mid-June of 1962. From then until 2012 would cover half a century or about one investing lifetime.
You would have been able to acquire 131 shares of Coke stock at $76.50 per share in 1962. By June of 2012, 50 years later, based on actual Coca-Cola stock events, you would own 6,288 shares as a result of stock splits, trading at $77.44 per share, or a $486,943 market value for your entire position. Along the way, you would have also received dividend checks totaling $136,271. Thus, your $10,000 turned into $613,214.
Your results would have been even better than they appear because the dividends would have provided far more purchasing power back then. In other words, $1 in dividend income back in 1962 would buy far more than $1 in dividend income today.
For example, for the full year 1963, you would have collected $353.64 in cash dividends. That equates to about $2,652.04 after adjusting for 50 years of inflation.
To put the performance in perspective: Even after paying dividend taxes, assuming you had a typical family of two parents and two or three children, your Coca-Cola dividend income would have provided enough cash to take an extended, paid-in-full vacation at Walt Disney World every three years.
In the five decades that you held the stock, you could have enjoyed 16 or 17 quite nice family vacations, courtesy of your Coke dividends. On top of that, you would ultimately have $486,943 in Coca-Cola shares sitting in your brokerage account, which would now generate $12,827.52 in annual cash dividends paid to you each year.
That isn’t bad for never having to invest any more money or effort after making your initial investment back in 1962. That investment success story is a testament to how powerful compounding can be when you own high-quality stocks.
The Opposite Scenario: Dividends Reinvested
What if instead, you had reinvested those Coca-Cola dividends, had foregone the enjoyment of a family vacation every three years and, instead, increased your shares held in the business? You can answer that question if you were to look at 50 years of historical dividend and stock price data for The Coca-Cola Company.
To answer, your 131 shares of Coke, bought in 1962, would have grown into an estimated 21,858 shares by 2012. The market value would be between $1,700,000 and $1,800,000, and your annual cash dividends would be more than $42,000. All of that wealth came from a single $10,000 seed planted back during the time John F. Kennedy was in the White House.
So, Should You Reinvest or Not?
Would you rather have enjoyed over $136,000 in cash along the way and taken 16 or 17 vacations with your family, or would you rather have an extra $1,100,000 or so today, along with the $30,000 of annual cash dividend income that comes with it?
No right or wrong answer exists because whether or not you reinvest the cash depends on your situation, goals, objectives, personality, and your need for funds. For a young, well-paid executive who could afford whatever her family needed, reinvesting the dividends might have made perfect sense.
Today, as a retiree, the former executive would be glad she made that election as she received the $42,000 in cash dividends each year courtesy of Coca-Cola, the Atlanta-based soft drink giant.
On the other hand, a young employee struggling to make ends meet, who invested his $10,000 inheritance in Coca-Cola stock might have been better off using the dividend payments for enjoyment throughout his lifetime because the utility and enjoyment of those family trips would exceed the utility of the extra wealth today.
He would still end up with roughly $500,000 in his brokerage account and $12,000 in annual income from his dividends. That's a great result and, ultimately, your goal isn’t to die with the highest net worth possible.
Your goal is to die having used money as a tool to provide you with the most enjoyment and security you could possibly expect. Whether you reinvest your dividends or spend them, don’t be upset about it; think it through rationally and choose to be content with whichever path you choose. Never forget that your investment portfolio is there to serve you.
A Final Note: Market Losses
The research of professor Jeremy Siegel on stock market returns has illustrated that reinvesting your dividends during a market crash can result in recovering your total net worth much faster than you otherwise could.